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Research Support Services Inc. Submission in Response to Joint Finance Canada Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

November 28, 2007

Nancy Horsman & Peter C. Armstrong

Joint Finance Canada-Canada Revenue Agency SR&ED Consultations
140 O'Connor Street
Ottawa, Ontario
K1A 0G5

Subject: Improving the SR&ED Program – questions for consultation

This letter is in response to the Ministers of Finance/Canada Revenue Agency request for input regarding the SR&ED programme: its effectiveness in stimulating research and development in Canada, and the effectiveness of its administration. The format I have used is to first, state the question, and follow with my response. Where appropriate, I have attached some of my previously-written documents (published and unpublished) which I feel are particularly relevant to the SR&ED programme and its administration.

Personal and Other Background Information

My name is William (Bill) Robinson. I am a Professional Engineer by training. The SR&ED programme has been my primary business function for the past 17 years. My SR&ED experience began in 1990 in what was then the BC Telephone Company. In 1994 I started a SR&ED consulting business, working full-time for clients. My clients' fields of science and technology include communications, biotechnology, forestlands, wood products, manufacturing (wide variety), computer science, electronic instrumentation, and horticulture, among others. They range in size from multinational corporations with multibillion dollar revenues to a husband and wife Canadian Controlled Private Corporation (CCPC).

More than 90% of my clients are/have been Small and Medium Enterprise (SME) CCPCs employing 50 people or less. I participated in all three Revenue Minister's conferences (1998, 2000, & 2001), and was an Action Steering Committee (ASC)/Partnership Committee (PC) communications subcommittee member from 1998 until the disbandment of the Partnership Committee by CRA in 2006. Over the years I have written a number of published and unpublished papers on the topic of the Canadian SR&ED programme, its administration, and its effectiveness.

I have seen the programme in its best light, and at its very worst. In preparing my comments below, I draw on my vast experience with the SR&ED programme, and how the Investment Tax Credits (ITC) has affected the behaviour of my clients. Where possible, I have included specific examples, without compromising the confidentiality of my clients.

My Comments

a) How do the SR&ED tax incentives affect the performance of R&D in Canada, and how can they contribute to increasing private sector investment in R&D?

Among the specific areas that stakeholders may want to address are:

1. the role the SR&ED tax incentives play in the R&D investment decisions of Canada's R&D performers;

Response:

I cannot think of a single SME client where the SR&ED ITC received by the client was not either invested directly back into their research programme, or used to get them through a difficult business cycle. As an example: one CCPC in Microbiology used the SR&ED ITC to build dedicated research facilities, hire three full-time researchers, and currently has up to 20 employees participating in their programme 5% - 80% of their time. This happened over a four year period; the SR&ED ITC claims increased in amount as their R&D programme expanded. This expansion would not have happened without the SR&ED ITC; the business environment would not have allowed it. They now employ around 50 people, mostly research calibre technical personnel.

In another example, a CCPC client doing world class research into endangered plant material was hit with a serious plant disease. The SR&ED ITC was diverted from their research programme to keep the company viable, as well as research the disease itself. They will survive, and they will rebuild their research programme, but only through the graces of the SR&ED programme. This client employs two full-time researchers with up to 15 other employees participating from 20% to 80% of their time in SR&ED work. They employ over 30 people, and contract twice that number.

I can produce numerous other case studies if requested.

2. How multinationals make decisions on the location of R&D activities, and how SR&ED tax incentives, and R&D tax incentives offered by other countries, play into that decision.

I cannot comment on this question. I have no frame of reference or experience; any opinions would be speculation on my part. However, over the years I have been told by various individuals from large multinational organizations that the Research and Development tax incentives do impact decisions on where their corporate research work is done.

b) Are there features of the SR&ED tax incentives that impede the growth of small and medium sized innovative Canadian companies, and how?

Input is solicited on whether and in what way the legislated rules governing the SR&ED tax incentives create barriers to the growth of small and medium sized innovative Canadian companies, and on how firms currently manage the constraints.

Response:

Since its inception on May 19, 1985 the SR&ED programme has been on a tumultuous and emotional rollercoaster ride between being an incentive programme and a disincentive programme. If the SR&ED ITC programme was human, it would be diagnosed as severely schizophrenic. But the issue remains not with legislated rules; it remains with the interpretation of these legislated rules by the CRA in the administration of the programme. Distorted and inconsistent interpretation of the legislative rules and associated guidelines by the CRA remains the primary inhibiter to the growth of SME companies via the SR&ED ITC programme.

The problems the SME community faces today with the SR&ED programme are not new. In an October 12, 2006 letter to the Minister of the Canada Revenue Agency I identified communication between the CRA and industry as the primary problem with the current administration of the SR&ED ITC programme. This letter is given as Attachment 1 at page 10. Please note that a portion has been blacked out to protect the confidentiality of my client. The problems identified in the letter to the Minister continue today, as the CRA have systematically and deliberately severed all avenues of communications with industry on the administration of the programme. The CRA has taken the position that this is their programme alone, and they will administer it in accordance with other existing tax audit models.[1] In fact, CRA senior managers have stated that they are not interested in the success of this programme.[2]

In July 2000 I presented a paper in Taipei at the Pacific Economic Cooperation Council (PECC)International Symposium on Sustainable Small & Medium Sized Enterprises, titled "Practical Experiences with Fiscal Incentives for Technological Innovation: Research and Development Investment Tax Credits". The paper is given at page 12 as Attachment 2. It was based on personal SME experience with the Canadian SR&ED programme between 1990 and 2000. The historical issues with the SR&ED programme administration given in the paper (see pages 16-17) are as relevant today as they were in 2000. The problems stated in summary were:

  • The inconsistent implementation of IC 86-4R3 and IT 151-R4;
  • The science audit practices CCRA was following forced science reviewers to make judgments on technical innovation in fields of science beyond their specialized areas of expertise;
  • Inconsistent training of science advisors, both in industry and CCRA;
  • Although industry provided some anecdotal evidence[3] stating the importance of the SR&ED ITC's, they failed miserably by not demonstrating to the government how the SR&ED program affected their Canadian industrial R&D efforts.

In April 1999, I wrote an unpublished paper that was shared with the office of the Auditor General titled "Scientific Research and Experimental Development Investment Tax Credit Program: Implementation Issues in 1999 (Spring)". This paper is presented at page 24 as Attachment 3. The paper states (see page 26):

This report identifies what the "real issues" are with the current SR&ED ITC program implementation policy. These issues are not new, and were effectively deal with in the late 1980's and early 1990's with the introduction of Information Circular (IC) 86-4R3 and Interpretation Bulletin (IT) 151-R4. Where the program has fallen down is on the implementation of these documents, along with a complete lack of training, both in industry and Revenue Canada. There has been no continuation of the good work that went on in the earlier years. Industry has been derelict in identifying in meaningful terms the benefits of the program to technological innovation in Canada. Revenue Canada has fallen back into a "tax enforcement" attitude, which is not conducive to an incentive program.

The last sentence of this quotation is particularly relevant to where we find ourselves today. It is the way the CRA interpret and apply the legislative rules that is the problem.

I rely on the submissions of organisations such as the Canadian Advanced Technology Association (CATA), the Information Technology Association of Canada (ITAC), and the major financial institutions, to name a few, to provide the extensive supporting details on where the CRA is failing in its administration of the SR&ED ITC programme. For my part, my intention is to provide evidence that we have been here before; and that the solutions to the problems were developed and tested in the 1999-2003 time periods. They worked well for both industry and the CRA during this time.

c) How could more private sector R&D be leveraged?

Stakeholders may wish to comment on, for example:

1. whether the structure of the SR&ED tax incentives could be improved to encourage more private-sector R&D in a cost-effective manner; and

Response:

There are two major aspects of the current legislation that impede the growth of SME claimants:

1. The limit of $400K in taxable income before the refundability is stripped away. This severely inhibits SMEs to invest aggressively in people and equipment for research and development purposes. The original number was set at $200K in 1985. If one takes into account the rate of inflation over the past 22 years, a move to $400K is insignificant.

2. For example, in microbiology in 1985 the state-of-the-art laboratory equipment would have cost $80K. Today, the state-of-the-art microbiology laboratory equipment begins at $500K. As well, salaries for microbiology researchers have at least tripled over these 22 years.

My experience has convinced me that companies are willing to put their own money into research and development as well as SR&ED ITCs. However to grow their research efforts they need to have higher profitability; this means higher taxable income. Higher taxable income means they lose SR&ED ITC, which takes away from their available funds for investment in research and development. It becomes a vicious circle.

I recommend that the limit for CCPC refundability be increased to $1.5M of taxable income. This will increase the funds available to the SME community for investment in research and development.

The limit of $2M in eligible SR&ED expenditures for refundability for CCPC. I make a similar argument here as in #1 above. This amount was set in 1985. Costs of research have, at a minimum, tripled over the ensuing 22 years. As examples where this regulation has a major impact: start-up and spin-off organisations such as biotechnology companies, where today it requires enormous amounts of investment to carry an idea from concept through to commercialisation. It normally takes many years for this to happen. In its current form, the SR&ED ITC do not provide the required level of funding support. These firms now have to look to foreign venture capitalists for investment; in most cases it costs them their CCPC status, and loss of Canadian intellectual property.

I recommend increasing the expenditure limit to $10M for CCPC refundable SR&ED ITC expenditures. If the limit on eligible expenditures was raised to $10M, many more Canadian owned and controlled companies would at least have a fighting chance, and would increase the investment in Canadian researchers, thus helping reduce the "brain drain" that has been going on over the past 25 or more years.

In summary, the boundary conditions that were set for CCPC SR&ED ITC claims were established when industrial research and development was a fraction of its cost today. If these boundary conditions are not updated to meet the global business environment faced by innovative SME CCPCs, then the effectiveness of the SR&ED ITC will continue to diminish for this community. The income refundability limit needs to be increase to at least $1.5M and the expenditure limit for refundability should be increased to a minimum of $10M. Both these metrics should be regularly reviewed and increased to reflect changes that are occurring in the dynamic (turbulent) Canadian business environment.

2. how the SR&ED tax incentives could best support public-private R&D collaborations, as highlighted in the S&T Strategy.

Response:

History (2000 – 2003) has shown us that a joint industry – government collaborative approach to resolving the SR&ED ITC programme administration issues works well. If the SR&ED programme is going to thrive as an incentive programme to encourage industrial research and development in Canada, it is essential that all parties have a seat at the table to make it work. The administration of such an important programme cannot be left to the CRA alone.

It is my opinion that the Finance Ministry, the true owner of the programme, can no longer take a back seat to the administration of the programme. Three times the SR&ED programme has fallen off the rails, primarily because Finance has taken a hands-off approach, stepping in behind the scenes only when the programme ran off track. The CRA, left to its own devices, revert back to what they have been trained for, and do best – recovery. I believe it is the lack of leadership on the part of Finance that has caused many of the problems in the SR&ED programme that SMEs face today.

If a SR&ED tripartite oversight body was established representing the owner (Finance), the benefactors (industry), and the programme administer (CRA), we could begin to achieve the level of stability that has eluded us for the last 22 years. Such a body would become a model for public-private R&D collaboration, and would fix the SR&ED programme once and for all.

d) Given the improvements already implemented or under study, how could administration of the SR&ED tax incentives be further improved and their complexity reduced?

Consistent with the Government's commitments in Budget 2007 to reduce the paper burden and the tax compliance burden on businesses, comments are welcome on:

1. whether there are provisions of the program that are difficult to access; how severe such difficulties are; and what effect they have on the compliance burden, or on the amount of support the firm receives;

2. whether the CRA processes claims consistently and what the CRA can do to strengthen the level of consistency of the SR&ED claim review process;

3. whether there are areas of complexity within the program where the Government could improve/simplify the process for claimants while ensuring that the program is delivered as intended and that fiscal integrity of the program is maintained; and

4. how the Government can improve the way in which information about the program is provided, better improve the services provided, and ensure that businesses are aware of the program.

Response:

I have chosen to answer the questions in section d) as a group, rather than individually. I believe the recommendations that follow will address these four points.

As stated in section b) above, most of the SR&ED programme issues we face today are the same as we faced in 1999. It is helpful to refer to the recommendations I made in my April 1999 unpublished paper (see pages 32 – 35):

1. Establish an accepted and clearly understood science audit process

The Action Steering Committee (ASC) on January 14, 2000 issued the "Guide to Conducting a Scientific Research and Experimental Development Review". This document clearly stipulates how a SR&ED review will be conducted, the responsibilities of each party, and how to handle disagreements. It is as relevant today as it was in January 2000.

This recommendation was fulfilled; a clear review process was developed and published. The problem is that the CRA refuses to follow it, and there is no body with the authority to make them do so.

2. Establish Qualifications for Science Reviewers

To my knowledge there has been no collaboration done with industry to establish the qualifications for CRA Research Technical Advisors (RTAs). It appears that the CRA count more on graduate degrees rather than practical industrial research and development experience as qualifications.

This recommendation is still outstanding.

3. A Formal SR&ED Training Program

There has not been a formal SR&ED training programme established. However, there is evidence that such a training programme would greatly help to build a common interpretation/understanding of the SR&ED tax legislation. In the 2000-2003 there was a series of joint CRA – industry training sessions to discuss specific topics and application guidelines. These joint training sessions made it quite clear to all participants as to how to apply the legislation to specific industries and/or situations. Examples of such joint training sessions included the: Guidance on Eligibility of Software Projects for the SR&ED Tax Credits and Developing and Documenting Claims; Pulp and Paper Sector Guidance Document; Guide to Recognizing Experimental Development; SR&ED Chemicals Guidance Document (several different sessions); 2002-02 Experimental Development SR&ED Expenditures; and 2002-02R2 Experimental Development-Commercial Production, to name a few. These training sessions worked very well; they brought a common perspective to both the CRA and industry SR&ED claimants, which resulted in a period of stability with reduced confrontation.

This recommendation is still outstanding.

4. Clearly defined Responsibilities for Industry and Revenue Canada

Recommendation 1 above addresses some aspects of this recommendation. However, with the CRA Ottawa Headquarters SR&ED group abdicating any responsibility for the field SR&ED audits, industry is left to the mercy of the local SR&ED auditor, who may or may not understand the intent of the programme. Furthermore, industry has lost whatever influence they had in establishing and maintaining a fair and impartial administration of the SR&ED programme.

This recommendation is still outstanding.

5. External Advisory Report

This recommendation was partially fulfilled with the advent of the Action Steering Committee, followed by the Partnership Committee. However, with the actions of the CRA over the past three years, many of the gains flowing out of these committees have been lost.

Although the application guidelines and guidance documents remain in place, their implementation has been random and inconsistent. From my personal experience, the excellent application guidance documentation created by the ASC is being largely ignored by CRA. See Attachment 4 at page 37 as an example of my experience; all names have been either blacked out or changed to maintain confidentiality. In the CRA audit of this client's claim, six different guidance documents and/or tax law were ignored.

Currently, this recommendation is outstanding.

Page 21 of my paper presented in Taipei at the Pacific Economic Cooperation Council (PECC) International Symposium lists the requirements for a successful research and development tax credit programme. These requirements are given below along with my comments about their applicability in the current SR&ED environment:

An effective industrial research incentive program would have the following characteristics:

1. There must be clear and public government support for the incentives.

In today's SR&ED ITC programme, government support is somewhat confusing. On the one hand, the government counts on the SR&ED programme to be a major contributor in moving Canada from 14th place to 5th place in the OECD ranking for research and development. On the other hand, the CRA makes the programme very difficult for clients to use. Public opinion among SR&ED experts is that less than 50% of eligible companies are taking advantage of the programme. There must be more overt government support for the SR&ED ITC programme among the user community.

2. The goals for the incentives must be articulated as specifically as possible. This includes defining the target group(s) and anticipated benefits. If one group is to be favoured over another, the program should be skewed accordingly.

The goals of the SR&ED programme have never been well articulated, other to say the programme was established "to encourage industrial research and development in Canada". If the SR&ED programme is to be a key component of moving Canada from 14th place to 5th place in the OECD ranking, changes in the programme administration is essential. It is imperative that we bring in the estimated 50% of eligible companies that do not use the programme. Furthermore, steps should be taken to reduce the administrative burden placed on companies to do use the programme. It will be important to establish specific metric targets for the SR&ED ITC programme.

Federal and Provincial Governments have done an excellent job of attempting to favour the SME community over publically traded/foreign owned companies. However, further adjustments are required to update the parameters for this segment, as stated above.

3. The benefits of the incentive program must be meaningful within the business environment.

The SR&ED programme has been a valuable and essential tool to the CCPC community to help them grow their research and development programmes. However, the SR&ED incentive programme has lost its meaning to many public traded/foreign owned companies. The 20% tax credit is of little benefit to those large corporations who are not in a taxable position, and will not be for years to come. The SR&ED ITC are needed now, not in the future, and may mean the difference of a successful transition to the new paradigm or failure. The forest products and manufacturing industries are current examples. It is imperative that refundability be given consideration for this segment. Some type of refundability is strongly recommended for the 20% category of companies.

4. The incentive program should have the essential elements of credibility, predictability and stability built into its implementation. The rules and requirements must be simple, and clearly understood by all participants.

In the 2000 – 2004 time periods, these criteria were essentially met. The Partnership Committee had developed the key tools necessary for programme stability and credibility. The leadership provided by the CRA Ottawa Headquarters group produced greater consistency across the country. However, without the presence of Finance on the committee, the CRA was successful in undermining, and eventually eliminating, the PC. The demise of the PC, coupled with the abdication of responsibility by CRA Headquarters, has led us back to chaos. The schizophrenia continues.

What I believe is required is the establishment of a tripartite committee with representation from the Minister of Finance (owner), Industry (benefactor), and the CRA (administrator). This committee must be empowered to adequately ensure the fair and impartial administration of the programme, while ensuring the requirement of fiscal responsibility is met. Industry representation should come from across the diverse spectrum of SR&ED users, who have the pre-requisite experience and understanding of the SR&ED programme requirements. It is imperative that Finance be at the table to ensure their goals are being met, and that the CRA administrator stays within the defined boundaries. The CRA, as the administrator, is an essential participant in the committee. This body must ensure that the programme fulfills its mandate, and does not create an unreasonable administrative burden for the user community.

5. Implementation and administration should be done through an impartial body that is not perceived as threatening to industry, yet will ensure the public welfare is protected.

With the tripartite committee in place, the SR&ED programme should remain with the CRA. Most of the tools and the solutions to the many thorny issues were resolved in the predecessor ASC/PC, and are still relevant. The administrative structure for overseeing the programme is in place. What is needed is a new organization in the CRA Headquarters that re-establishes the technical resources to provide the necessary leadership and expertise; pre-requisites for an incentive mindset. The restructuring process should move the SR&ED division out of the regular audit function, reporting directly to the Commissioner of the CRA. I believe equal participation of industry, Finance, and CRA at the tripartite committee level would bring the long-sought stability to the SR&ED programme.

6. The costs and benefits of the incentive program should be measured for both the users and the funding body, to ensure the program goals are being met.

Both government and industry have failed in this regard. To my knowledge, there is no credible academic research work that demonstrates the benefits of the SR&ED ITC to the economic well-being of Canada. This needs to be funded by both Finance and industry, and conducted through a credible university suited to conduct such research.[4]

At the same time, industry has failed to advise the government in quantified terms how they use the SR&ED ITC benefits to advance research and development in Canada. It will be important for the future well-being of the SR&ED programme that industry meets their responsibility on this topic.

In Conclusion

The current SR&ED programme woes are not new; they are a resurgence of ghosts from the past. What I have presented above is a series of problems along with possible alternative solutions to the current state of the SR&ED programme. What is missing is the mechanism to start the ball rolling.

I suggest that the Minister of CRA, in concert with the Minister of Finance, convene a national Minister's SR&ED conference similar in stature to the 1998 Minister of National Revenue conference. Such a conference would provide a forum to re-establish a meaningful dialogue between industry, Finance and the CRA to turn things around in a significant way. Direct Ministerial involvement was the only thing that resolved the 1990's situation; the same result could be achieved today if all participants are seriously committed to improving the SR&ED programme.

Please be advised that I authorise the Minister of Finance to post this submission on their website. The required information for posting is as follows:

Name: William J Robinson
Company: Research Support Services Inc
Mailing Address: 2625 Fortress Drive
Port Coquitlam, BC V3C 6G7
Telephone Number: (604) 942-9642
Facsimile: (604) 942-9673
Email: robinson@researchsupport.ca

If you require any further information please do not hesitate to contact me at the above contact information. I look forward to your early reply to this letter.

Yours truly

William J. Robinson
CEO Research Support Services Inc.


Attachment 1: Letter to Minister of National Revenue

October 12, 2006

The Honourable Carol Skelton

Minister of National Revenue
Parliament Buildings
Ottawa, Ontario

Dear Ms. Skelton:

Subject: State of the Scientific Research and Experimental Development (SR&ED) Investment Tax Credit Programme for Small and Medium Enterprises

I would like to bring to your attention reasons why I believe the CRA is detrimentally impacting the SR&ED programme delivery to the Small and Medium Enterprise (SME) community in British Columbia, and across Canada. My concerns are based on the following:

The SR&ED programme is the primary means for encouraging industrial research and development for the Canadian government, as well as eight of the provinces plus the Yukon. Since its inception on May 19, 1985, it has seen good times and bad. Prior to 1994, it was an excellent programme for the SME community; from 1995 – 1999, the CRA changed the management of the programme, making it complex, confusing, and difficult for industry to use, particularly the SME community. In BC, many SME's in the high tech industry went under when the CRA denied their SR&ED claims that previously qualified; money that had been counted on to fund their research activities. From 2000 to 2003, the programme dramatically turned around to become a flagship programme for both the CRA and Industry, in terms of government support and its cooperation with industry. However, in the past three years, it has reversed direction once again and is being administered as a disincentive, rather than an incentive program.

So what has happened to cause such an erratic, inconsistent ride? It has to do with communications between the CRA and industry. In 1986-88, the CRA and industry worked together to develop an agreed upon set of criteria on how to recognise SR&ED in an industrial setting. These were captured in Information Circular 86-4R, which is now used by the tax courts as the basis for determining whether work is SR&ED. From 1994-1999, the CRA issued some 21 interpretation guidelines based on their own arbitrary analysis; many interpretations were neither fair nor proper. By June 1998 the situation had became so severe that the Minister of National Revenue (Herb Dhaliwal) called a national conference inviting industry and senior CRA staff to address the problem. Out of this came a joint industry - CRA working group (Action Steering Committee) with an agenda to resolve some 13 different problem areas. Two additional Minister's Conferences (January 2000 and May 2001) contributed greatly to the healing process. Over the next five years, this joint body produced some 12 guideline documents that significantly clarified common understandings between CRA auditors and taxpayers. The Ottawa CRA headquarters SR&ED group was instrumental in implementing these changes to the field, and provided both the necessary leadership and expertise to the field personnel. In mid 2003, the leadership of the SR&ED programme in Ottawa changed once again, and once again, the programme changed direction. The Headquarters group began abdicating any responsibility for programme leadership, focusing only on policy issues. They eliminated the majority of their HQ science and financial experts leaving the field CTSO staff with nowhere to refer their problems. This vacuum has led to the resurgence of arbitrary decisions that ignore application policies, information circulars, and, in some circumstances, actual tax law. As a consequence, some SME's are having great difficulty getting their claims approved. They do not understand the complexities of the programme, making them easy prey to CRA auditors' fixation on maximum recovery. As one example: in the 2005-2006 review of one SME, the CRA auditor issued a disallowed science review report that blatantly violated/ignored 8 different guidance documents, tax law (Section 248(1)), and Information circulars. The SME's request for a second opinion was denied by the Assistant Director. I have heard of similar instances from the Calgary CTSO and other eastern offices through my SR&ED contacts across the country. Clearly, the SR&ED programme is in great peril of returning to the dark days of the 1990's, which would not be good for industry or the Canadian economy.

From my personal experience, SR&ED has been the lifeline that has allowed many SME's to not only expand their research work, but to traverse financially difficult times. (YYYY) They are recovering and will survive, but only because their SR&ED programme benefits have kept them afloat. In another example, a sheep farmer in the BC Interior has a breeding research programme involving African, European, and South American animals that is recognised in Canada, the US, Australia, and Europe as leading edge practical agricultural research work. The closure of the US border to meat imports from Canada, coupled with drought conditions and lack of local slaughter facilities has driven them to the verge of bankruptcy. It has been the SR&ED programme that has saved them. I raise these two SME examples because their long term research goal is not to sell plants and animals, but to research and develop horticultural/agricultural intellectual property that they can market worldwide. The demand is there, but the research is not complete.

My request to you is that you give serious consideration to convening another national Minister's SR&ED conference similar to the previous three. Such a conference would provide a forum to re-establish a meaningful dialogue between industry and the CRA to turn things around in a significant way. Direct Ministerial involvement is the only thing that resolved the 1990's situation.

For reference, I have been a full time practitioner of SR&ED for the past 15 years. I have worked with Simon Fraser University as a Research Associate at the Centre for Policy Research on Science and Technology (CPROST) regarding SR&ED and other governmental research support mechanisms for industry. I am well qualified to talk about the current SR&ED state of affairs for the SME community, and how it has evolved.

Thank you for taking the time to consider my letter and its content. A special thanks to the Honourable James Moore for conveying it to you on my behalf. If you have any questions or wish to contact me for any reason, you can do so at 604-942-9642 or via email at robinson@researchsupport.ca.

Yours truly

(original signed by)
William J. Robinson


Attachment 2:

Practical Experiences with Fiscal Incentives for Technological Innovation:

Research and Development Investment Tax Credits

Prepared by

William J. Robinson

For

THE PACIFIC ECONOMIC COOPERATION COUNCIL

INTERNATIONAL SYMPOSIUM ON
SUSTAINABLE SMALL & MEDIUM SIZED
ENTERPRISES
13-14 July, 2000
Chinese Taipei

William J. (Bill) Robinson
RANDITC Consulting Ltd.
2625 Fortress Drive
Port Coquitlam, BC, Canada V3C 6G7
Telephone (01) 604-942-9642
Facsimile: (01) 604-942-9673 or 944-9443
Email: robinson@randitc.com

Abstract

It is a well-established and accepted premise that small and medium sized enterprises (SME's) are key members of the technological innovation community. Their industrial research and development initiatives are seen as the driving forces behind both emerging and established economies on all continents. It is therefore in the interest of all levels of government to encourage and nurture SME industrial inventiveness within their region.

This paper discusses the Canadian experience of using research and development tax incentives as a means of encouraging greater levels of domestic SME industrial innovation. The basis of the discussion is the Canadian model, known as the Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC) program. It discusses the successes and failures of the model, why they occurred, and how the problems might be circumvented. It goes on to identify how research tax incentives can be a very effective tool for spawning technological advancement and development in all industries, and in particular those identified as emerging, such as ecological and environmental fields of science. The conclusions are that all of the essential tools to create an effective research and development investment tax incentive program have already been developed. All that remains is to follow through with an effective implementation strategy. A model is presented for an implementation strategy that avoids the problems encountered in the Canadian experience.

Introduction

Canadian governments have been using tax incentives to encourage greater industrial research and development (R&D) work in Canada since 1944. There is a common belief that such incentives lead to greater economic growth through higher employment and other related ripple economic benefits.[5] Over the years there have been many iterations of the tax incentives. The current program is called the Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC) program; it was initiated in 1985, and is the federal government's primary mechanism for supporting and encouraging industrial R&D in Canada. Eight of the ten Canadian provinces provide their own additional add-on benefits to the federal SR&ED investment tax credits. The most lucrative of these are in Ontario and Quebec, which have the largest provincial economies. The Ministry of Finance established the applicable SR&ED ITC tax law, while the Canada Customs and Revenue Agency (CCRA) has the responsibility for implementing these laws. The current tax law defining SR&ED is given as Attachment 1. There have been only minor changes since its introduction in 1985.

The SR&ED ITC program is deliberately biased towards Canadian Controlled Private Corporations (CCPC's). CCPC's receive a 35% refundable tax credit on all eligible SR&ED expenditures up to $2M, provided the previous year's income was less than $200K. Publicly traded companies, foreign owned companies, and individuals receive a straight tax credit of 20% to be applied against income, which can be carried forward for up to ten years.

The Canadian SR&ED Experience

When the SR&ED ITC program was launched in 1985, it got off to a rough start. No allowances were made to scientifically evaluate whether a company's SR&ED ITC claim met the SR&ED requirements as identified under tax law. Accountants were making judgments on scientific matters, which led to differing and adversarial opinions between claimants and tax auditors. By 1987 the Canadian government realized engineers, scientists and other technical people had to evaluate the merits of SR&ED ITC claims. They hired science advisors to take on this role. In 1987 – 88 CCRA science advisors and industry worked together to develop an extensive set of guidelines, which established the basic criteria and circumstances for identifying SR&ED eligibility. These efforts produced an excellent Information Circular (IC) 86-4R2[6], which has since been accepted by the Canadian tax courts as the basic standard for interpreting what industrial research is eligible under SR&ED tax law. Various industry-specific addendums have been added in the intervening years. As well, Information Technical bulletin IT 151-R4 was produced, which identified those costs that qualified as eligible SR&ED expenditures[7]. Both Industry and CCRA began working towards science audit protocols that would eventually lead to SR&ED eligibility self-assessment by taxpayers, and risk-management style audit reviews[8].

From 1988 through to 1992, the SR&ED program enjoyed a period of relative calm. Many more companies were becoming aware of the SR&ED benefits, and successful use of the program went from 4,000 to 5,500 CCPC's in these years. The number of other companies taking advantage of the SR&ED tax incentives remained relatively constant at around 1,000 firms. In this period, $4.4B in SR&ED ITC's were claimed, with 23% of this going to less than 1% of the companies. Thirty-four percent went to CCPC's, which were primarily SME's[9].

By 1993 the outflow of SR&ED tax credits had reached such a significant level that it caught the attention of the Minister of Finance. At least five different committees were struck to evaluate the implementation of the SR&ED program, and to determine the benefits to the economy from these SR&ED ITC's[10]. In 1994 the Auditor General of Canada in his annual report severely criticizing both the Ministries of Finance and Revenue for their inadequate management of the SR&ED ITC program[11].

In 1993 there was a change in leadership of the SR&ED science audit division. The new regime was clearly sensitive to the stinging rebuke in the Auditor General's 1994 report. The Minister of Finance was concerned at the rapidly rising number of claims for internal software development, particularly in the banking and telecommunications sectors. As well, in 1994, a loophole was closed that had allowed claimants to go back as many as ten years to pick up previously unclaimed SR&ED work. Prior warning that the loophole was to be closed resulted in a deluge of more than 9,000 additional claims[12]. By 1995, these factors led to a dramatic change in the CCRA Science Advisors' interpretation as to what qualified under the program guidelines. Consequently, from 1995 to 1998, the SR&ED program fell into great disrepute with industry. It became an administrative burden rather than an incentive program. Disputes regularly arose over the eligibility of projects as well as their expenditures[13]. As of March 31, 1999 there were some 7,680 claims worth $5B in SR&ED tax credits still unresolved, some going as far back as 1985[14]. Many of these remain unresolved today. Between 1994 and 1996, CCRA issued sixteen different application policy documents reflecting changes in what was deemed to be eligible SR&ED expenditures. Documentation requirements to validate and support SR&ED claims became unreasonable, going well beyond normal business practice.

Impact on the SME Community

In 1997, over 11,000 companies filed for more than $2B in SR&ED ITC's. Eight percent of the claiming companies accounted for 85% of these ITC's; these were all large corporations[15]. This left over 10,100 companies to share $300M in SR&ED ITC's: on average, $29,700 per company.

By 1998, a large number of SME claimants, particularly in the software development industry, abandoned the SR&ED program; the benefits were not worth the increased administrative burden. Scientific evaluation of the claimed work was inconsistent and inappropriate, leading to lengthy appeals and frustration on the part of the SME community. Large corporations dominated the SR&ED program use, and the concerns of the smaller companies were not being heard.

In 1998, the Minister of National Revenue held a two-day conference to discuss what could be done to improve the SR&ED program. Five issues requiring thirteen action items came out of the conference. A joint Industry – CCRA steering committee was established to resolve the action items. Although SME's were well represented at the conference, they have never had a presence on the steering committee. To date, SME SR&ED ITC program users have seen marginal improvement in most areas across the country. The fundamental problems for the SME SR&ED users remain the same: excessive administrative burden, unfair science audits, and overly complex expenditure guidelines[16].

On the plus side, those SME's and other corporations who used the program benefited greatly. Two particularly noteworthy areas of science and technology are Ecological/Biodiversity and Herbal Medicines. In one instance, the SR&ED ITC's have allowed a SME to establish a research program that takes endangered wild plant species from China, conduct 3-5 years of original and application research on the plants, and develop commercially viable hybrid species for the horticulture market. Some of the plants will be returned to China, to be planted into the wilderness. In other instance, the SR&ED ITC's have enabled a SME to expand its research into the development of commercially viable agriculture crops of wild medicinal plants and herbs. In a third example, the SR&ED ITC's have allowed a biological and pharmaceutical SME to initiate a research program into analyses of the medicinal properties contained in complex mixtures of herbal medicines.

Research work at the Simon Fraser University (SFU) Centre on Policy Research for Science and Technology (CRPOST) in 1993-94 provides evidence that the provincial add-on programs have been effective for many of the provinces[17]. Further validation of this observation was given in a 1997 SFU informal discussion paper for the BC provincial government[18].

Why the Canadian SR&ED Program Began to Lose its Way

By the beginning of 1993, CCRA had in place the essential tools for establishing a long-term stable SR&ED ITC program. The criteria established as essential for any SR&ED ITC claim were technological advance, technological uncertainty, and technological content (systematic investigation). IT 151-R4 provided a set of clear guidelines as to what expenditures were considered eligible for an SR&ED ITC claim. Claimants could easily determine which costs should be included, which should not, and build a reasonable claim.

Information Circular 86-4R3 eloquently articulates what constitutes technological advance, technological uncertainty, and technological content. It goes on to establish the premise on which these three criteria are to be evaluated, as follows:

"Scientific research and experimental development varies in content as well as complexity in a given field. The technical uncertainties encountered by one taxpayer may well be looked upon as facts easily obtained by another. The judgment as to eligibility should be made within the context of a single company and its field of business. Specifically, the activities undertaken to resolve technical uncertainties are eligible if the taxpayer cannot obtain the solutions through commonly available sources of knowledge and experience in the business context of the firm. We expect that any firm claiming expenditures for scientific research and experimental development activities will have or will access the expertise necessary to carry out a viable program."[19]

The major reason the SR&ED ITC program fell down was the inconsistent implementation of IC 86-4R3 and IT 151-R4. Scientific Research and Experimental development activities need to be assessed for eligibility in the context of what technical information was available to the taxpayers at the time the SR&ED occurred. The determination of what is and what is not SR&ED work in any industry is a context dependent subjective decision. Without any specific science audit guidelines to follow, each decision will be based on the reviewer's experience, standards, work ethics, and training. Even with guidelines, without a process to implement the guidelines, people revert back to their own standards base, which may or may not be appropriate for the review under consideration. In the Canadian situation, neither industry nor CCRA had a consistent understanding of how IC 86-4R3 or Section 248 (1) of the Income Tax Act should be interpreted. CCRA did not have a formal science audit process. The people who were conducting the CCRA science audits had a myriad of standards by which they evaluated SR&ED claims. Claimants had their own interpretations of how the three eligibility criteria should have been applied

The inconsistent science reviews led to the SR&ED claims becoming very much a game of Russian roulette. Claimed SR&ED ITC's developed into business uncertainties because disallowed claims produced unexpected tax bills, financial instability, and, in certain circumstances, bankruptcy for SME's. Since businesses could not predict the success of their SR&ED claims with confidence, they reduced their research and capital expenditures accordingly. Many firms decided they could not tolerate the situation and/or the increased administrative burden, so they abandoned the program.

The second reason was somewhat related to the first, as it had to do with the qualifications of the CCRA science auditors. In almost all sectors of science and technology, this was a major issue. The science audit practices CCRA was following forced science reviewers to make judgments on technical innovation in fields of science beyond their specialized areas of expertise. Rather than admit a limited knowledge base and look to the client to clarify the state-of-the-art of the specific technology, science auditors often took a position based on their own limited knowledge base, which often was totally inconsistent with the actual technological circumstances. As well, science auditors were making evaluations in fields of science and technology where there was very little commonality with their own technical training. As examples, an Environmental Engineer evaluated horticulture research work, and a Computer Science Analyst evaluated instrumentation and control electronic research activities.

The third reason the program began failing was because of minimal training of science advisors, both in industry and CCRA. The lack of a proper training policy further exacerbated the inconsistent interpretations of what was and what was not SR&ED. Too many science auditors did not understand the history of the program, or its intent. They were left with their own personal biases, with no clear understanding that the SR&ED program is the government's primary means of promoting industrial innovation in Canada. They were unaware of the larger implications of the work they did, and its overall impact on Canada's ability to maintain its position in the world of science and technology.

The final reason the program started to fail rests with industry itself. The Office of the Auditor General made it quite clear in its 1994 report that the governing ministries could not identify in quantifiable terms the benefits to the Canadian economy flowing from the SR&ED ITC's. This was a clear message to industry that they had to take meaningful steps to inform the government of how the tax credits were used to benefit both themselves and Canada. Although industry provided some anecdotal evidence[20] stating the importance of the SR&ED ITC's, they failed miserably by not demonstrating to the government how the SR&ED program affected their Canadian industrial R&D efforts. There was, and is, no explicit evidence that demonstrates whether the SR&ED ITC's achieve the defined goals of the increased Canadian industrial R&D work.

All of these issues were further compounded by the fact that by 1994 CCRA began following a de-centralized approach to the science audit process. As a consequence, not only were there interpretation inconsistencies within a region, there was further inconsistency across regions.

In summary, the excellent 1987 – 92 efforts that established the SR&ED program as an incentive for encouraging increased industrial R&D in Canada vanished. CCRA had fallen back into a "tax enforcement" attitude, which is not conducive to an incentive program. At the same time, it must be noted that industry has been derelict in identifying in meaningful terms the benefits of the program to technological innovation in Canada.

What we have learned from the Canadian SR&ED Experience

There is little doubt among business, government, and academe circles that the SR&ED ITC program has produced significant benefit to Canada. Major international corporations such as Nortel Networks, Magna International, Bombardier, Nova Chemicals, and others are quick to point out that the SR&ED ITC's are a major consideration when they decide where they will conduct their research projects.

Canada has a reputation of producing highly trained talented technical people. The fact that we now live in a "World Economy" where technical workers are mobile and corporate loyalty is waning leaves Canada extremely vulnerable to knowledge worker "raiding" by the US and other industrialized countries. Essentially, Canada faces an increasing danger of becoming an exporter of knowledge workers, rather than an exporter of knowledge. The fact that large international conglomerates are using the SR&ED program as a factor in determining where their research products projects will be done can lead to no other conclusion than the program is meeting its goal of increased industrial research and development work being done in Canada. However, the extent to which this is happening remains to be quantified and further qualified.

Other lessons that we can take from the Canadian SR&ED ITC program experiences:

1. For a successful tax incentive program, there must be a clear understanding among all of the participants as to what the ground rules are. Moreover, these ground rules cannot be open to political interference.

2. It is equally important that all participants understand how the ground rules will be implemented. All participants must be able to make high confidence predictions on the outcome of their use of the program.

3. Implementation of the tax incentive program must be done in the context of the business environment. Administrative simplicity and expediency are paramount.

4. Although tax incentives are an effective mechanism for increasing domestic industrial R&D work, it cannot be left to the taxation department to implement these incentives. The taxman has always been concerned with enforcement and recovery, which is not conducive to an incentive program.

5. The implementation policies of the Canadian SR&ED program have resulted in the SME community being overshadowed by the larger companies, even with favoured treatment for CCPC's.

6. Ownership does not make a good distinction for favoured status. Too often SME's must look towards the venture capitalists for R&D funding. In most cases this leads to a critical loss in CCPC status and reduced SR&ED tax incentives, just when they are most needed.

7. The benefits of the tax incentives should not be taken for granted. There should be quantified as well as qualified measurements that demonstrate the objectives of the tax incentives are being achieved.

Essential Facts About Government Tax Incentive Programs for Innovation

The Canadian experience has shown government fiscal incentives are an effective means for encouraging greater domestic industrial technological innovation. However, tax incentives must be looked at in the light of what they truly are. As stated in the 1994 Canadian Auditor General's report:

"In many ways, tax expenditures are not different from direct expenditures. They represent a transfer of funds from all taxpayers to those taxpayers who are performing a desired activity, in this case scientific research and experimental development. Every dollar of investment tax credits allowed to one company must be paid for by all other taxpayers. Seen in this light, it is important that Parliament hold the government to account for this spending through the tax system. The structure of the implementation program must ensure the interests of all parties are protected."[21]

Any government tax incentive program must ensure the interests of the general tax paying population are protected. One way to do so is to require companies to first spend their investment capital on eligible activities, and then make their claims. Validation of the eligible work is required through some type of reasonable audit process. As well, those who are funding the research and development work are entitled to know that their money is well spent, and the benefits outweigh the costs.

At the same time, the process cannot overburden industry users of the programs. Administrative obligation has to be looked at against opportunity costs, as technical workers are already stretched to the limit in today's business environment. The benefits need to be substantial and meaningful, if they are to be effective. It is important that any detailed information revealed as to how the incentives benefit the firm be kept confidential, to protect its competitive position in the marketplace.[22] Finally, program stability and predictability for users is essential. Without these features, users cannot develop strategic business plans that incorporate the benefits of the incentives, which ultimately defeats the whole purpose of the incentive.

The Ingredients for a Successful Research and Development Tax Incentive Program

The most important ingredient for any R&D incentive program is clear and public commitment by the government agencies involved. Businesses will not take any program seriously without it.

The incentives must have a specific target in mind, and produce meaningful benefits that have at least been qualified, if not quantified, for all parties involved. If the incentives are to be targeted at specific fields of science, or business organizations, this needs to be made clear at the outset.

Any incentive program should have elements of predictability and stability built into its implementation. It follows that the implementation structure be as immune as possible to political or business interference. That does not mean governments cannot make changes to the program; it means they must do so overtly rather than covertly.

Finally, all interested parties must have a clear understanding of the ground rules, how they are going to be implemented, and what avenues of recourse are available. To be a viable program, it must be kept as simple as possible, without complex financial and/or technical tracking requirements that go beyond normal business practices.

Building a Successful Research Tax Incentive Program

The Canadian SR&ED ITC program provides the essential tools and experience for the establishment of a successful domestic industrial innovation tax incentive program. What is missing is a fair and impartial implementation process that protects the interests of all parties.

A successful SR&ED program must have audit processes that are transparent, consistent, dependable, trustworthy, fair, professional and free from personal conflicts and conflicts of interest. Section 248 (1) of the Canadian Income Tax Act, IC 86-4R3 with its appendices, and IT 151-R4 with its interpretive guidelines, provide a solid rule base from which the R&D incentive program can be administered.

The incentive program implementation process has to clearly establish the responsibilities of each party in the process. It cannot be seen as threatening or overly burdensome by industry; at the same time it has to ensure the legitimacy of the claim. As an example, the process may dictate that industry has the responsibility of establishing how it differentiates eligible research work from routine development work. What criteria are used? How are they applied? Who makes these decisions, and what are their credentials for making such decisions? What is their level of understanding of the incentive program, and the process to be followed? These questions allow the science auditor to focus more on auditing the company's eligible project selection process and its technical environment, rather than the individual detailed projects. Following this process makes it possible to have science audits by science auditors with a general understanding of an industry, without detailed knowledge of the specific technology in question. It reduces the subjective "grey region" in terms of what is and what is not eligible R&D for a specific field of science. Similar risk-management techniques would be used to validate financial expenditures being claimed.

It is equally important that qualified people be responsible for the audit process. The review process requires individuals who have demonstrated research experience in a specific field of science. Examples of qualification requirements could include essential experience in conducting industrial R&D, preferably within the past five years. To ensure fairness, the qualification criteria for the auditors could be established jointly by the review agency and industry. These criteria must satisfy the audit credibility requirements of the government, as well as protect the interests of industry. Financial auditors would have to have industrial audit experience. Industry has the additional responsibility to help identify individuals who meet the requirements, and who are capable of conducting impartial and transparent science reviews.

A successful innovation incentive program will not happen without a common understanding of the program. This can only come about through the development of a formal training course, available to all parties. To prevent any biasing of the course material, an independent body should develop the curriculum. A typical course outline should cover all aspects of the incentive program to include: program intent, history, identification of industrial R&D, categorization of industrial R&D, audit purpose, audit process, and a whole series of practical examples. Qualified people with extensive experience and expertise in the research incentive programs would teach it. The course should be a pre-requisite for all auditors. Successful completion of the course would give students formal "Science Advisor Certification"[23].

Finally, the agency established to administer the implementation of the research incentive program must be seen as impartial. It should require people who have a well-grounded understanding of industrial R&D, how it occurs, and how it differs from institutional R&D. The Canadian experience has revealed that in today's business world, most technical universities and institutions have developed strong ties with industry, not just in Canada, but also in most emerging and industrialized countries. Consequently, a consortium of technical universities could provide an acceptable body for overseeing and administering a research and development incentive program. Their recent experiences with the industrial R&D environments, coupled with their traditional R&D role, gives them the knowledge and credibility to be impartial adjudicators. Furthermore, they are best positioned to conduct the types of research necessary to both qualify and quantify the effects of the incentives, not only to the recipients, but also to the regional and national economies. Very little research has been done in this area because of the inherent difficulties associated with population identification, access to information, and lack of a clearly defined structure.

Conclusions

Practical experience with the Canadian SR&ED ITC program has demonstrated that government tax incentives can be effective for encouraging greater domestic industrial technological innovation. These incentives can be specifically targeted to one business sector, or applied as a general offering. Over its life, the Canadian SR&ED ITC program has created a variety of excellent tools that can be used to develop similar programs in other regions. At the same time, this program has taught us the pitfalls that must be avoided if the program is to meet its objectives.

An effective industrial research incentive program would have the following characteristics:

1. There must be clear and public government support for the incentives.

2. The goals for the incentives must be articulated as specifically as possible. This includes defining the target group(s) and anticipated benefits. If one group is to be favoured over another, the program should be skewed accordingly.

3. The benefits of the incentive program must be meaningful within the business environment.

4. The incentive program should have the essential elements of credibility, predictability and stability built into its implementation. The rules and requirements must be simple, and clearly understood by all participants.

5. Implementation and administration should be done through an impartial body that is not perceived as threatening to industry, yet will ensure the public welfare is protected.

6. The costs and benefits of the incentive program should be measured for both the users and the funding body, to ensure the program goals are being met.

Summary

In today's business environment, technology is advancing so rapidly that many products and services are obsolete even before they progress from the prototype stage to commercialization. At the same time, each prototype advances both the technical knowledge base and the technology of the firm and the industry. However, the advent of the modern global economy, with its mobile technical work force, makes it increasingly more difficult to protect valuable knowledge workers from international "high tech raiders". The loss of the skilled R&D workforce and their companies further hampers a country's ability to compete in the international marketplace. One instrument to mitigate these losses is the use of earned research and development tax incentives. The Canadian Federal Scientific Research and Experimental Development Investment Tax Credit program has demonstrated such instruments are very effective as domestic industrial innovation incentives. It provides an excellent model to follow, complete with toolsets, successes and failures.


Attachment 1

Section 248 (1) of The Canadian Income Act

"Scientific research and experimental development"

"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

(e) 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 in respect of a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing or psychological research, where the work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b), or (c) that is undertaken in Canada by or on behalf of the taxpayer,

but does not include work with respect to

(e) market research or sales promotion,

(f) quality control or routine testing of materials, devices, products or processes,

(g) research in the social sciences or the humanities,

(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,

(i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,

(j) style changes, or

(k) routine data collection;

William J. (Bill) Robinson

Personal information

Bill Robinson is an independent management consultant specializing in Scientific Research and Experimental Development Investment tax credits incentives for private industry. He is the principal of his own software development company, which develops secure Internet and Intranet software for research project information capture and project management. Mr. Robinson is an associate faculty member of the Simon Fraser University Institute for Business and Innovative Studies.

Mr. Robinson began his career with a Communications Technologist diploma in 1964. In 1975 he attained a Bachelor of Applied Science degree in Electrical Engineering at the University of B.C. In 1982 he completed an Executive Masters of Business Administration Degree at Simon Fraser University. His vocation has taken him to overseas and Arctic assignments for a total of seven years.

Bill's extensive career includes work in the fields of telecommunications marketing, human resources, and R&D management. His roles in the technical realm have ranged from maintenance technician, station manager, project engineer, to R&D manager. In non-technical fields, he has worked as a market analyst and consultant, human resources counsellor, continuing education planner for professional engineers, as well as human resources manpower planner. He spent six years teaching marketing, microeconomics, and management theory classes at the college level. His consulting expertise is primarily in the management of technological innovation, with the goal of maximizing resource utilization. His counsel is a culmination of his broad industry experience.

Mr. Robinson is an active member of the Association of Professional Engineers and Geoscientists of BC, the SFU executive MBA alumni, and the SFU Institute for Business and Innovative Studies. One of his principal interests is in the field of continuing education for professional workers and technology managers in both industry and government.

 


Attachment 3: Scientific Research and Experimental Development Investment Tax Credit Program: Implementation Issues in 1999 (Spring)

Scientific Research and Experimental Development Investment Tax Credit Program:

Implementation Issues in 1999 (Spring)

An Independent Report

Prepared by

William J. (Bill) Robinson
RANDITC Consulting

April 8, 1999

Table of Content

Executive Summary

Introduction

2.1 Background

2.2 Current status

2.3 Recent Events

3. The "REAL ISSUES"

3.1 Implementation of IC 86-4R3

3.2 The Science Audit Process

3.3 Training

3.4 Qualifications of the Science Auditors

4. Recommendations

4.1 Establish an accepted and clearly understood science audit process

4.2 Establish Qualifications for Science Reviewers

4.3 A Formal SR&ED Training Program

4.4 Clearly defined Responsibilities for Industry and Revenue Canada

4.5 External Advisory Report

5. Summary


1. Executive Summary

The Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC) program is the Federal government's primary mechanism for supporting and encouraging industrial research and development (R&D) in Canada. It is intended as an incentive program for furthering technological innovation in Canada.

In recent years the SR&ED ITC program has fallen into disrepute with industry. Several reports have been prepared and submitted to the Minister of National Revenue identifying what the primary problems are, and why the program is not working for industry. In June 1998 the Minister committed himself and his Ministry to resolving these problems, and to putting the program back "on track". In September 1998 a joint government-industry steering committee was established to implement the thirteen action items that came out of a June 26 and 27 1998 "Building Partnerships" conference.

It is now almost ten months since the Minister of National Revenue made his commitment to industry to improve the SR&ED ITC program. To date, the state of affairs in the SR&ED ITC program has not significantly changed, particularly for the SME environment. Those companies who have abandoned the SR&ED ITC program because it has become too difficult and administratively burdensome see no reason to come back to the program. If anything, the chasm between industry and Revenue Canada has only widened.

The action steering committee does not seem to be making meaningful progress. There is no evidence of success in coming to grips with the key problems that surround Revenue Canada's current SR&ED implementation policy.

This report identifies what the "real issues" are with the current SR&ED ITC program implementation policy. These issues are not new, and were effectively deal with in the late 1980's and early 1990's with the introduction of Information Circular (IC) 86-4R3 and Interpretation Bulletin (IT) 151-R4. Where the program has fallen down is on the implementation of these documents, along with a complete lack of training, both in industry and Revenue Canada. There has been no continuation of the good work that went on in the earlier years. Industry has been derelict in identifying in meaningful terms the benefits of the program to technological innovation in Canada. Revenue Canada has fallen back into a "tax enforcement" attitude, which is not conducive to an incentive program.

The report goes on to make a number of recommendations on how the program can be revived with active participation by industry, academe, and the government. Too much effort is being wasted in attempting to "re-invent the wheel". There is inordinate emphasis on placing blame, and not enough on addressing the real problems in the current SR&ED program implementation policy. By levering off the experience of those people who revived the program in the late 1980's and early 1990's, it is possible to take rapid and meaning steps to resolve the current outstanding issues. The return to a revitalized incentive program will require all parties to play an ongoing active role in sustaining the SR&ED program.

2. Introduction

2.1 Background

The Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC) program is the Federal government's primary mechanism for supporting and encouraging industrial research and development (R&D) in Canada[24]. It emerged in its present form in 1983[25], and currently distributes around $1.2B annually to some 11,000 qualifying companies[26]. It has undergone several changes in the intervening years[27].

In recent years Revenue Canada's implementation policy for the SR&ED ITC program has caused considerable friction between Revenue Canada and industry, particularly in the small and medium enterprise (SME) companies[28]. In May and June 1998 the Minister of National Revenue received two independent reports identifying the major problems with the SR&ED program[29] [30]. He responded by calling a joint government/industry two-day "Building Partnerships" conference in Vancouver on June 26 and 27, 1998. The conference concluded with the Minister of National Revenue publicly committed to fixing the SR&ED ITC program[31].

At the conference some five different major initiatives were identified, which led to some thirteen separate action items. The implementation of the action items fell on the shoulders of the Action Plan Steering Committee, which is made up of representatives from Revenue Canada and Industry. The primary function of the SR&ED Program Steering committee is to lead the implementation of the action plan developed in response to the recommendations put forth at the June 1998 SR&ED Conference Building Partnerships. Through this committee, industry set up a number of industry specific task forces to investigate SR&ED implementation problems in that industry[32].

2.2 Current status

To date the state of affairs in the SR&ED ITC program has not significantly changed, particularly for the SME environment[33]. Those companies who have abandoned the SR&ED ITC program as too difficult and administratively burdensome see no reason to come back to the program. If anything, the chasm between industry and Revenue Canada has only widened. In March 1999, Revenue Canada issued a document identifying how they perceived a science audit should be conducted[34]. This document was not done with industry consultation, and in fact does nothing more than perpetuate the "Statue Quo". Reaction from industry has been mixed, at best. A recently released draft document that identifies the rights of the taxpayer during the SR&ED audit process is slanted at perpetuating the current state of affairs in the SR&ED ITC program[35]. Again, there appears to have been no consultation with industry for the document.

The implementation steering committee has not delivered any meaningful progress for industrial users of the program[36]. They have now held a total of four separate meetings. The minutes of these meetings reflect similar topics to the discussions of the June 26/27 1998 conference. It is not possible to identify when this committee will produce tangible improvements in the SR&ED ITC program, especially the SME's.

2.3 Recent Events

In early October 1998 two SR&ED industry task forces were set up for the purpose of investigating key issues impacting SR&ED ITC claims for the one industry segment. One task force was composed product companies, and the second was made up of services companies. Each task force was asked to recommend a course of action to overcome these issues.

Each task force spent considerable time and effort researching the problem issues relating to their specific experiences in using Canada's SR&ED program. After a thorough analysis of the key findings of each task force, there was noted to be a high degree of correlation between the issues coming out of the two task forces. These issues focused around the following themes:

  • Definition of a SR&ED project
  • Advancements in knowledge vs. Advancements in Technology
  • Incremental technological advancements vs. the radical breakthrough
  • Experimental development vs. scientific research
  • System integration and SR&ED eligibility
  • Technical risk vs. business risk, and the technical environment
  • Documentation requirements
  • Audit timing, methodology, and qualifications of the science auditors.
  • Joint venture SR&ED work, and the Revenue Canada audit process

When these issues were compared to the findings of other industry sectors, again a high correlation was noted[37]. A series of separate issue reports that address the specifics of the task force findings were prepared. However, there was very little effort made to going beyond these key issues to identify the root of the problem. This report focuses on the underlying issues relating to the common problem areas. It identifies the "real issues", and provides a series of recommendations on the resolution of these problem areas.

3. The "REAL ISSUES"

3.1 Implementation of Information Circular (IC) 86-4R3

In today's scientific environment, technology is advancing so rapidly that many products and services are obsolete even before they progress from the prototype stage to commercialization. At the same time each prototype advances both the technical knowledge base and the technology of the firm and the industry.

The originators of the Information Circular (IC) 86-4 series of documents wisely recognized these facts. When they developed the 86-4R2[38] document, they understood the interpretation of what is SR&ED can best be described using the three criteria of technological advance, technological uncertainty, and technological content. They further understood that it is virtually impossible to police the application of these criteria across all sectors of a specific field of science and technology. To this end, the "context" in which the three criteria are to be applied must take into account the business environment of the taxpayer. Thus we see in the IC 86-4R3 guidelines comments such as:

"2.11 Application of Criteria

The three criteria of IC 86-4R3 must be applied within the context of the taxpayer's business environment.

Scientific research and experimental development varies in content as well as complexity in a given field. The technical uncertainties encountered by one taxpayer may well be looked upon as facts easily obtained by another. The judgement as to eligibility should be made within the context of a single company and its field of business. Specifically, the activities undertaken to resolve technical uncertainties are eligible if the taxpayer cannot obtain the solutions through commonly available sources of knowledge and experience in the business context of the firm. We expect that any firm claiming expenditures for scientific research and experimental development activities will have or will access the expertise necessary to carry out a viable program."[39]

"2.13

The definition of "experimental development" in subsection 2900(1) of the Regulations requires that work be undertaken to achieve technological advancement when creating new, or when slightly improving existing materials, devices, products or processes. For an experimental development activity to be eligible in terms of scientific research and experimental development it must conform to the spirit of the legislation; that is, it must seek to advance the taxpayer's technological knowledge base. The technological advance achieved has only to be slight."[40]

"2.14

In summary: If the primary objective is to make further technological advancements in the product or process, then the work meets the criteria for experimental development. If, on the other hand, the technological character of the product or process is substantially set, and the primary objective is to develop markets, to do pre-production activity, or to get a production or control system working smoothly, then the work no longer meets the criteria. However, if technological uncertainty exists under these circumstances, then the work on studies to resolve the technological problems may still be eligible. This is amplified in later sections."[41]

"4.2

A key distinction between eligible and ineligible activities is the difference between experimental development and development based solely on "standard practice" in established fields of engineering or technology. Standard practice refers to the directly adapting a known engineering or technological practice to a new situation where there is a high degree of certainty that the known technology or practice will achieve the desired objective.

Specifically, projects predominantly using "standard practice" are based on commonly available experience, and development activities based on it generally are ineligible. When "standard practice" is utilized in support of an eligible experimental development activity, the associated activities are of course eligible. Ultimately, the definitive judgement of what is or is not standard practice in a given field of technology can only be made by specialists familiar with that field."[42]

To access whether or not the three SR&ED eligibility criteria have been met by a taxpayer, one needs to determine:

  • Technological Uncertainty for whom?
  • Technological Advance for whom? and
  • "What information is commonly available in the public domain, and what could the taxpayer be reasonably expected to know about the technologies involved?"

In practice, however, the current Revenue Canada science audits inconsistently and frequently do not make allowances for either the business environment or the current state-of-the art at the time the SR&ED work took place. There is very little emphasis on the technological advancements to the firm, but rather focus on how the technical work advances the overall field of science and technology. There is very little consideration given to the technological resources available to the firm; instead, emphasis is placed on what resources are available in the whole Canadian marketplace, at any cost.

The real issue becomes the implementation and interpretation of IC 86-4R3 and associated documents.

3.2 The Science Audit Process

The determination of what is and what is not SR&ED work in any industry is a context dependent subjective decision. Additionally, determination of the context and environment in which a taxpayer is carrying out its research and development activity is becoming increasingly difficult. Without any specific science audit guidelines to follow, each decision will be based on the reviewers experience, standards, work ethics, and training. Even with guidelines, without a process for the implementation of the guidelines, people will revert back to their own standards base, which may or may not be appropriate for the audit at hand.

Scientific Research and Experimental development activities should be assessed for eligibility in the context of what technical information was available to the taxpayers at the time the SR&ED occurred. When circumstances such as financial funding become a factor, it must be recognized that not all taxpayers are equal. Financial resource availability dictates the different alternative technical solutions available to the researchers. This, in turn, will impose limitations on the technical knowledge base that can be allocated to the project. Subsequent consequences can be seen in the term "routine engineering or development". What is routine engineering or development in the circumstances of a limited financially resourced company may not be routine technical work in the circumstances of a well-funded project with "deeper pockets". This is why IC 86-4R3 specifies that science audits are to be conducted "within the context of a single company and its field of business". Only science reviewers who have an intimate knowledge of the predominant field of technology under investigation should do the determination of what is routine technical work. A proper science audit process is essential, if these different factors are to be taken into consideration.

It is impossible for any one person to maintain a level of technical expertise in any single field of science and technology, particularly if they are not actively involved in research. It is ludicrous to think Revenue Canada can maintain a reserve of experienced science advisors who understand at a detailed level all aspects of each field of science. It is therefore essential the science audit review process be resilient enough to accommodate today's wholesale rampart chaotic technological evolution.

Revenue Canada does not have a formal science audit process. They have various drafts of a science advisor Technical Operations Manuals. Industry experience has shown the majority of Revenue Canada science advisors either do not know of these manuals, or choose to ignore them. To further exacerbate the issue, the people who are conducting the science audits have a myriad of standards by which they evaluate SR&ED claims. There is no consistent understanding of how IC 86-4R3 or Section 248 of the Income Tax Act should be interpreted.

The issue is further compounded by the fact that in recent years Revenue Canada has followed a de-centralized approach to the science audit process. As a consequence, not only is there interpretation inconsistencies within a region, there is inconsistency across regions.

The real issue is the lack of an acceptable science audit process that can be used to conduct a transparent, unbiased, fair science audit, independent of the current state-of-the-art of technology, for all parties involved.

3.3 Training

Revenue Canada has no formal science audit training process. Each region is left to its own devices in terms of training and indoctrination of both consultants and Revenue Canada science advisor employees. Furthermore, there is very little in the way of a training budget. The consequences of this policy (or lack of) are inconsistent interpretation of what is and what is not SR&ED. Too many science auditors do not understand the history of the program, or its intent. They are left with their own personal biases, with no clear understanding that the SR&ED program is the government's primary means of promoting industrial innovation in Canada. They are unaware of the larger implications of the work they do, and its overall impact on Canada's ability to maintain its position in the world of science and technology.

Revenue Canada has not been in a position to adequately direct or coach industry on how to identify what is SR&ED in their specific organizations. This leads to great inconsistencies across different taxpayers and industry sectors in the presentation of industrial SR&ED that meets the criteria identified in 86-4R3. A few industrial associations have been more successful at establishing some common guideline benchmarks among its registered members, but even these are inconsistent[43]. However, for the most part, there has been little initiative taken on the part of industry on the training issue.

The real issue is that there is no formal SR&ED training program, either for industry or Revenue Canada. This has led to great disparity among science advisors and consultants as to what is SR&ED, and how this should be interpreted in an industrial R&D setting.

3.4 Qualifications of the Science Auditors

In almost all sectors there has been a major issue with the qualifications of the science auditors. Technology is evolving so rapidly it is impossible for even those technical specialists directly involved in R&D to keep up with the changes in their field of science. The existing science audit practices force science reviewers to make judgements on technical innovation in areas beyond their specialized area of expertise. Rather than admit a limited knowledge base and look to the client to clarify the state-of-the-art of the specific technology, science auditors often take a position based on their own limited knowledge base which is totally inconsistent with the actual technological circumstances.

The best example of this problem is seen in the fateful Revenue Canada Telecommunications task force established under David Seal. This task force was assigned the responsibility of reviewing all the telecommunications companies 1993 and 1994 SR&ED claims for eligibility. The science audit process, and the reports emanating from this process, clearly demonstrated that the science consultants were not qualified to conduct such a science review. The complete 18-month science audit process only worsened the confrontational relationship between Revenue Canada and the Telecommunications industry. Settlement of these claims still eludes both parties[44].

Industry for its part has not been pro-active in assisting Revenue Canada with this problem. Often they themselves cannot find the qualified resources they need to do their research work. As well, many taxpayers are fearful of confidentiality, and conflict-of-interest issues. On the other hand, every year there is a large pool of qualified researchers who retire from the regular work force, but would make excellent impartial science consultant auditors. Industry has done very little to inform Revenue Canada of their availability.

The real issue is the credentials of those individuals who are conducting the science audits. Revenue Canada often has great difficulty in finding science consultants suitably qualified to assume the role of a science consultant auditor.

4. Recommendations

Revenue Canada and the Department of Finance have lost sight of the fact that Industrial SR&ED is not classic formal SR&ED, but is "informal" SR&ED. It is an evolving process that incorporates the technology state-of-the-art, intuition, technical knowledge, systematic investigation, cost, feasibility, and most important, compromise.

At the same time, Industry for its part has not informed the government on how the SR&ED ITC program is benefiting Canada. There has been no quantitative or qualitative research work that shows how the benefits from the SR&ED ITC program justify its cost to the Canadian taxpayer. Evidence of this comes from a 1994 Auditor General report which states:

"There are many ways for the government to achieve its economic and social objectives. The most visible is direct government spending on programs, grants, and subsidies. The government also pursues its policy objectives through measures (such as tax deductions, credits, exclusions, and income tax deferrals) contained in the income tax system. Because those measures represent alternative forms of government assistance, with financial implications similar to those of direct expenditures, they are generally referred to as tax expenditure.
In many ways, tax expenditures are not different from direct expenditures. They represent a transfer of funds from all taxpayers to those taxpayers who are performing a desired activity, in this case scientific research and experimental development. Every dollar of investment tax credits allowed to one company must be paid for by all other taxpayers. Seen in this light, it is important to account for this spending through the tax system".[45]

If the SR&ED program is to extricate itself from of its current state of "brokeness" it is essential that both Revenue Canada and Industry play a major role in how the SR&ED program will work in the future. To this end, the following recommendations are made.

4.1 Establish an accepted and clearly understood science audit process

A successful SR&ED program must have a science audit process that is transparent, consistent, dependable, trustworthy, fair, professional and free from personal conflicts and conflicts of interest. Before anyone can participate in a fair game, both sides must have a clear understanding of what the rules will be, and how they will be implemented. For example, "what is considered unacceptable contact with the opposing players?" If you are talking about a Rugby match or football, you have one interpretation. If you are talking about soccer or basketball, you have another. A Ping-Pong match will bring a third interpretation.

Section 248 (1) of the Income tax act, IC 86-4R3 with its appendices, and IT 151-R4[46] with its interpretive guidelines, all provide a solid rule base from which the SR&ED program can be administered. What we do not have is a clear set of guidelines as to how all of these guidelines are to be used during a science audit. Any implementation process that is put forward has to clearly establish the responsibilities of each party in the process. As an example the process may dictate that Industry has the responsibility of establishing how it differentiates industrial SR&ED from routine development work. What criteria are used? How are they applied? Who makes these decisions, and what are their credentials for making such decisions? What is their level of understanding of the SR&ED program, and the process to be followed? These questions allow the Science Auditor to focus more on auditing the company's SR&ED project selection process and its technical environment, rather than the individual detailed projects. Science audit decisions would have to be well founded and validated. By emphasizing the selection procedure, the auditor is forced to focus on the process more than the individual technologies involved. Vague unsubstantiated statements such as "this is commonly available knowledge" would not be accepted. This directs the audit process to rely more on the expertise of the company's technical people, rather than the expertise of the science auditor. However detailed audit sampling of projects should also be done, to ensure compliance with the company's selection criteria. Following this process makes it possible to have science audits by science auditors with a general understanding of an industry, without detailed knowledge of the specific technology in question. It reduces the subjective "Grey region" in terms of what is and what is not SR&ED for a specific field of science.

An excellent model for the development of the science audit process is found in Dr. Morley Lipsett's paper: "The Scientific Basis of Canada's R&D Tax Incentives: How to spot and claim every qualifying Research and Development Expenditure." The paper was presented at the May 4 1994Annual Tax Executives Institute Canadian Tax Conference, at Hull, Quebec. A copy of the paper is attached to this report.

4.2 Establish Qualifications for Science Reviewers

The science review process by itself will be insufficient to resolve the current problems. The review process implementation requires individuals who have demonstrated research experience in a specific field of science. Examples of qualification requirements could include essential experience in conducting industrial SR&ED, preferably within the past five years; alternatively, intensive formal training on the SR&ED science audit process, and demonstrated experience in conducting science audits.

Revenue Canada cannot be expected to produce qualified science reviewers by itself. They are not close to the individual industry sectors, or the current state-of-the-art of their relevant fields of science. Participation by the different industry associations becomes an essential factor. The qualification criteria for science reviewers must be established jointly by Revenue Canada and industry. These criteria must satisfy the audit credibility requirements of Revenue Canada, as well as protect the interests of industry. Additionally, industry has a responsibility to help Revenue Canada identify individuals who meet the requirements, and who are capable of conducting impartial and transparent science reviews.

4.3 A Formal SR&ED Training Program

Regardless of the quality of the science audit process and the science auditors, a successful SR&ED program will not happen without a common understanding of the program. This can only come about through the development of a formal SR&ED training course, available to both Revenue Canada and industry. To prevent any biasing of the course material, an independent body should develop the curriculum. Preference should be given to a University with an extensive knowledge base of the SR&ED program, and industrial SR&ED. A typical course outline should cover all aspects of the SR&ED program to include: program intent, history, what is industrial SR&ED, how to categorize industrial SR&ED, audit purpose, audit process, and a whole series of practical examples. Qualified people with extensive experience and expertise in the SR&ED program would teach it. In the longer term, the course could be a pre-requisite for Revenue Canada science auditors. Successful completion of the course would give students a formal "Science Advisor Certification".

The course when developed must be available across Canada. It must not place an undue financial burden on either industry or Revenue Canada, so must be financially self-sufficient. At the same time, it must not be so expensive as to put it out of the reach of small and medium sized enterprises. Finally, it must be kept current, and should include one-day refresher seminars.

(NOTE: The intent of the training course is not to replace the existing Revenue Canada seminars. These should continue on a regular basis.)

4.4 Clearly defined Responsibilities for Industry and Revenue Canada

The successful implementation of a fair SR&ED program requires each side to clearly understand what is expected of them. These expectations need to be articulated in language that can be understood by all program participants. Furthermore, they must take into account first-time filers who will not meet the requirement, and will require a "grace period".

These expectations will flow out of the recommendations given above.

4.5 External Advisory Report

The current issues surrounding the SR&ED program are similar in nature to those that were present in the 1986-87 time period. The resolution of these issues introduced the concept of science advisors, and produced such documents as IC 86-4 and IT-151. Great effort by both Revenue Canada and Industry was expended to produce a science review process that led to a number of years where the SR&ED program was truly seen as an incentive program. The recommendations outlined above reflect a return to the SR&ED program as it was at the turn of the decade and the early 1990's.

The current SR&ED program situation is different from the 1986-87 situation in one very important fact. Today we have an extensive set of excellent interpretive guidelines upon which a fair and impartial science audit process can be built. These guidelines are not significantly different from what they were in 1988. It does not therefore make sense for Revenue Canada and Industry to re-learn the experiences and solutions that followed the development of the guidelines. It is therefore recommended that an outside advisory body be engaged to prepare a detailed report addressing the recommendations made in this report.

The advisory group would be contracted to develop a detailed science audit process that is fair and transparent to all parties. The process must protect the interests of the government, while ensuring equitable and impartial treatment of all SR&ED program users. It should be built using IC 86-4R3, IT-151R4, and associated interpretative guidelines as its foundation. It must embody those principles that are identified with an incentive program.

The advisory group would then go on to identify in detail the characteristics of individuals responsible for implementing the process. This part of the report should not only identify educational, experience, and other requirements, it should go on to make recommendations on where these individuals should come from. The role of industry associations, Revenue Canada, and Universities needs to be identified, in terms they can easily deliver.

The next step for the advisory group would be the development of a detailed curriculum for a formal SR&ED science advisor course, as recommended in this report. The course must be independent of Revenue Canada, and open to both industry and Revenue Canada science advisors. It should teach the complete science audit process in a manner that will minimize the opportunity for misinterpretation and misunderstanding.

Once the advisory group completed its report, it would be submitted to the Revenue Minister's joint Revenue Canada - Industry Action Plan Steering Committee for discussion and implementation. It is anticipated the report will expedite the activities of the committee, and dramatically reduce the amount of background work required to fulfill its mandate.

The advisory body should include individuals who were participants in the resolution of the 1986-87 problems, and the establishment of the initial science audit process. Participants should have extensive SR&ED program experience that covers both the good and bad times of the program. Dr. Morley Lipsett at Simon Fraser University would be an ideal candidate to take charge of the advisory body.

5. Summary

It is the conclusion of the author that the current problems with the SR&ED program go beyond industry specific issues. A detailed analysis of how this program is being implemented in industry by Revenue Canada identifies the following facts:

  • IC 86-4R3 with associated appendices and extensions, and IT 151-R4 with associated interpretive guidelines are excellent documents for identifying technical work which is eligible for the SR&ED program.
  • The primary problem with the current SR&ED program is the lack of a consistent national science review process. A new national science audit process must be developed using the above mentioned documents as its foundation
  • There is inadequate and inconsistent training of science advisors in Revenue Canada and industry. A completely new certified science advisor training program is required. It should be developed and delivered by an independent body such as a University.
  • Qualifications for science advisors and science consultants are inconsistent and unclear. Specific detailed eligibility requirements need to be established.
  • An advisory group should be contracted to develop the details of the science audit process, the training course, and establish the essential criteria for science auditors.
  • The specific responsibilities of industry and Revenue Canada in the overall SR&ED program implementation need to be clearly identified and spelled out.

Attachment 4:Examples of CRA Ignoring Application Guidelines

March 27, 2006
(YYYY)
Dear: (YYYY)

SUBJECT: Company X 2002-2003 SR&ED Claim: Request for a Second Opinion

We are requesting a second administrative review of the Company X 2002 and 2003 SR&ED claims. This request follows the process laid out in step three, page 4 of the Application Guideline 2002-02R: Guidelines for resolving claimants' SR&ED concerns; dated June 30, 2005.

Here is the sequence of events so far according to our understanding of the review:

1. The initial COMPANY X claims for 2002-03 were submitted to CRA in October 2004.

2. A CRA site visit was arranged with (YYYY) Without any forewarning, (YYYY) showed up with a consultant, (YYYY) as well as (YYYY). During the site visit (YYYY) stated that he had no experience with the development of small pleasure craft boats, which is the category that best fits the COMPANY X claims.

3. On June 30, 2005 (YYYY) sent out a letter advising the client that (YYYY) had been contracted to conduct the technical review of the COMPANY X claim.

4. On July 5, 2005 (YYYY) issues a science report prepared by (YYYY) disallowing the whole claim. This report carried the signatures of (YYYY), as well as (YYYY). We took great exception to this report, as we believed it took an academic perspective, making no allowances for the fact that this was shop floor SR&ED.

5. On August 30, 2005 a rebuttal letter to the draft science report was sent to (YYYY), with a copy to his manager, (YYYY). This letter outlined how the draft science report ignored and/or ran contrary to at least six different SR&ED guidance documents, including IC 86-4R3. The letter is given as Attachment 1 of this document.

6. On August 31, 2005. (YYYY) and I met with (YYYY) to discuss the COMPANY X science report. This is in accordance with steps one and two of the Guideline for resolving claimant's SR&ED concerns. At this meeting we discussed the fact that the COMPANY X was shop floor SR&ED, and should be considered in that context. (YYYY) implied that he would do so. In exchange, we agreed to provide a much better timeline and supporting evidence for the work claimed.

7. On October 28, 2005 (YYYY) sent me an email asking why the additional information had not been provided. The client, Mr. Client had been in the Queen Charlottes since the beginning of September and out of contact. See attachments two for the many email correspondences on the subject.

8. On November 17, 2005 the requested additional information was sent to (YYYY). See attachment 3 for this letter.

9. On February 28, 2006 we received the final science report, which takes the same position as the draft science report of July 5, 2005. In our opinion, there was no credence paid to our concerns, and the violations of the guidance documentation stated in our August 30, 2005 letter remained in the final science report. Furthermore, this report implies that a letter requesting more information was sent directly to the client; we have not seen this letter, so cannot comment. The client is currently in the Queen Charlotte Islands and not in communications. (YYYY) was explicitly requested in September-October to send all correspondences to me or to (YYYY) (YYYY).

Since Company X is a first-time claimant we are somewhat surprised that there has been little leniency shown with respect to the supporting technical evidence for the claim. The client has been able to produce: 1. an accurate event-timeline from the logbooks kept by the lodge managers and other documents; and 2. photographic evidence of the problems encountered and the solutions followed.

This project illustrates the great difficulty small organisations with limited resources face when attempting to research and develop boats for an extraordinary hostile operating environment. In this instance, the shop floor had to be extended to include the waters off the Queen Charlotte Islands and the North Coast of BC. Key evidence that demonstrates the difficulty COMPANY X encountered while researching and developing boats for these waters is the contrast between the undamaged hulls of the boats built after November 2003 as shown in the pictures provided; and the pictures of the earlier experimental models with the extensive hull damage. As was stated in the November 17th timeline, the results of the 2002-2003 sea trials produced a boat design that has proven highly successful for COMPANY X. This would not have happened without the extensive 2002-03 sea trials involving the 31 experimental boats over the two years as we reported in the project documentation.

Based on the above we believe the science review of the COMPANY X claim is flawed; it did not follow either a legitimate review process or the guidance documents applicable to this review. The Guide to Conducting a Scientific Research and Experimental Development Review was certainly not followed. The June 30th letter from (YYYY) issued so late after the site visit certainly raises questions about her role in all of this, and whether or not she was given the full story. It is our position that we have a valid request for a second review of the COMPANY X claim.

If you have any questions in this matter, please contact me at 604-942-9642. We look forward to your early response to this letter as to your decision for going forward.

Yours truly,

(Original signed by)
William J. Robinson
C- (YYYY)
(YYYY)


Attachment 1: Rebuttal Letter of August 30, 2005

August 30, 2005

(YYYY)
Canada Customs and Revenue Agency
Science Advisor
1166 West Pender Street
Vancouver, BC V6E 3H8

Dear:

(YYYY)

SUBJECT: Company X Draft SR&ED Review Report

Please be advised that we do not accept the conclusions in the Company X draft science report. It is our contention that the report is based on flawed reasoning, and its conclusions were not made in accordance with the CRA guidelines and practices. Furthermore, the process that was followed was not in accordance with the acceptable CRA SR&ED review guidelines. In accordance with Application Guideline 2000-02R "Guidelines for resolving claimants' SR&ED concerns" we are taking the first step in rebutting the report by petitioning you to reconsider your science evaluation of the COMPANY X claim. Below we present some examples of our reasoning:

1. The draft SR&ED Technical Review Report makes several references to the concept that there was no "systematic testing" of the boat structures (pp 7, 10, 11, 12, and 13). On page 7 the report goes on to say: ".... That is no record of sea conditions, boat speed, stress measurements, hull motion, acceleration, pressure measurements were done. There is no reference to the exact conditions or the forces that caused the structural failures. The process can be described as a trial and error method."

From an academic perspective, these might be interesting or relevant measurements to take in the sea trials for an ocean-going vessel. However such measurements were not at all relevant to the COMPANY X experimentation. As an example the original science report for project 02-001 (New Boat Design - Eighteen foot Outboard Aluminium Boat) states in Section A on page 1: "The primary technological objective of this project is to research, build and implement a new eighteen foot aluminium power boat design for the commercial sports fishing lodges on the BC Northern West Coast and the Queen Charlotte Island waters. The boat must be rugged enough to withstand the constant pounding of heavy seas (Queen Charlotte Island waters); a boat life expectancy of 10 years operation; fast (> 25 knots); dry (minimal splashing on passengers while running in rough (8 foot) seas); and stable (up to 750 lbs at one side of the boat). It was further stated: "Our goal was develop a manufacturing process that produces boats to a tolerance of .010 inches, within a budget of $16K (boat only)."

The technological objectives given above clearly state that the boats are not designed to withstand a single operational condition; they are designed to withstand the pounding day-in and day-out on these boats caused by the rough waters off the BC Northern West Coast and the Queen Charlotte Island waters over the course of full year. The technological uncertainties relate to the effects of the constant pounding and rough sea conditions over time, not a specific circumstance of sea conditions.

Science report 02-001 goes on to say in Section B page 4 (What was the state-of-the-art when the project began? (Why this is a scientific or technological advancement and not the routine application of readily available knowledge and skills?)): "To our knowledge, no one has successfully designed and developed a cost-effective, reliable, recreational aluminium boat that can withstand continuous use in the rough Queen Charlotte Island/Northern BC Coastal waters, without ongoing and continuous structural repairs. Currently, metal boats used by commercial sports fishing organizations in these waters have a life span of no more than five years, with three years being the typical life of any existing aluminium boat design. The extensive pounding administered by these waters takes its toll in terms of mechanical and structural fatigue that cannot be overcome through standard boat design techniques."

The science report states in Section C page 5: 1. It was technically uncertain how or whether we could achieve an economical 18 foot aluminium boat design which would meet a 10 year life expectancy in the rough waters off the Queen Charlotte Islands/Northern Coastal waters. To date, all attempts by other boat builders had failed. Standard boat design techniques proved inadequate. Stated another way: "It was technically uncertain whether the experimental boat we designed and built at a cost of < (YYYY), could maintain its mechanical and structural integrity over time with the extensive pounding administered by these waters where we could reasonably anticipate a 10 year life span. No one else has been able to do so. The "Cross-Sector Shop Floor Guidance Document" dated July 29 02 states on pages 3 & 4: "Whether or not a given result or objective can be achieved, and/or how to achieve it is not known or determined on the basis of generally available technological knowledge or experience. This criterion implies that we cannot know the outcome of a project, or the route by which it will be carried out without removing the technological uncertainty through a program of experimental development. Specifically, technological uncertainty may occur in either of two ways:

  • it may be uncertain whether the goals can be achieved at all; or
  • the company 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.

The technological uncertainty, rather than the economic or financial risk, is important in characterizing experimental development and, hence, eligible work.

Sometimes there is little doubt that a product can be produced or a process can be developed to meet technological objectives when cost targets are no object. In commercial reality, however, a reasonable cost target is always an objective, and attempting to achieve a particular cost target can at times create a technological challenge which needs to be resolved. A technological uncertainty may thus arise that is imposed by economic considerations. Otherwise, the more general question of the commercial viability of the product or process is not relevant to whether or not a technological uncertainty is present and, hence, to whether a project is eligible or ineligible."

In the commissioning of any experimental design boat or ship, it is essential that the design undergo water trials in the most strenuous operating environment stipulated in the boat design criteria. This is a requirement of any company in the boating/shipping industry if it is to avoid legal liabilities. Furthermore, these water trials would be designed and implemented in a manner that will adequately demonstrate that the vessel meets design requirements. Science report 02-001 Section D (Technical approach and plan), page 7 states: "6. Build 21 boats for endurance trials in four different operating environments, for a six month period of time. This was a completely new boat design that had not previously been tested in either moderate or harsh sea conditions. Historically, industry boat manufacturing experiences in the Northern BC Coastal and Queen Charlotte Island waters has clearly demonstrated that building one or two prototype boats for endurance testing was not sufficient; a larger test population, in a variety of sea conditions was necessary. We therefore knew that in order to validate the design we had to build and subject a meaningful number of the prototype boats to extensive endurance testing in the actual application environment's found in these waters. We selected four different sites with different sea conditions. Each site would have a minimum of five boats to test, under normal operating conditions. We selected Tasu and Englefield on the West Coast of the Queen Charlotte Islands as the harshest water conditions; Tasu waters being harsher than those at Englefield. We selected Whale Channel and Big Time at the mouth of the Douglas Channel on the BC North Coast, with moderate-to-harsh conditions; Whale channel being the harshest water of the two." This plan meets the requirements of a systematic investigation in the COMPANY X business environment, and can hardly be viewed as a "Trial and Error method". There are no requirements in the SR&ED guidelines for "systematic testing", only for a "systematic investigation".

It should be noted and remembered that this is shop floor SR&ED, and not at a level one expects to see in laboratory and/or major SR&ED initiatives. In these COMPANY X SR&ED projects, the shop floor extends to and includes the seas found off the BC Northern West Coast and the Queen Charlotte Islands. The "Cross-Sector Shop Floor Guidance Document" states on page 4: "An SR&ED project begins when the technological objectives, as opposed to the business or commercial objectives, can be defined. An SR&ED project ends when the technological uncertainties are resolved. However, the commercial nature of the shop floor environment can often mask those start and end points." "In determining technological uncertainty, the claimant should also consider if there is system uncertainty. Because of the interaction of components/processes in the shop floor environment, system uncertainty can be a major consideration."

The knowledge of the size/force of a single wave, hull motion at any specific moment, acceleration in any single specific condition, or any other operating parameters for a single event, does not address the technological uncertainties in this project. Such measurements would not assist in addressing whether or not the experimental boats could withstand the extensive pounding administered by the operating environment waters or whether the stated technological uncertainty had been overcome. The only way to know whether the experimental boat design could withstand such pounding is through actual sea trials in the BC Northern West Coast and the Queen Charlotte Island waters.

As Client stated during the site visits he did a visual inspection of each experimental boat during the trial period; he was on site several times each month (generally every week) over the course of the test periods. In between visits, he relied on the lodge managers to immediately advise him of any structural problems with the boat, which they did do. Mr. Client stated that at the end of the season, the boats were torn down to investigate where stress is happening. He relied on feedback from the lodge managers via questionnaire regarding boat performance and suitability for the operating environment during the course of the trials.

This test protocol as described in the science report and carried out by Mr. Client may not meet the rigorous standards of sea-going vessel sea trials; however. it does meet the criteria of: "a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (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" in the context of the Company X shop floor SR&ED environment. It followed a defined test plan that does provide the data necessary to determine whether the technological uncertainties had been resolved, and whether the technological objectives had been met. Whether or not this process is viewed as trial and error in the eyes of academe is irrelevant. It was systematic; it followed a defined plan, and it produced the desired results. Whether a different methodology could have or should have been used is irrelevant; that is the process Mr. Client decided he could afford in his shop floor SR&ED business environment, and it was the methodology he implemented. The "Cross-Sector Shop Floor Guidance Document" states on page 3: "Technology as defined in IC 86-4R3 includes the application of scientific knowledge to industrial processes or product development. Note here that:

  • "industrial processes" may include business, commercial or other processes;
  • "application of scientific knowledge" includes the application of scientific, engineering and other technical knowledge; and
  • it is recognized that a technological advancement may occur; however the underlying scientific relations may not yet be fully understood.

In the context of the above definition of technology, seeking a technological advancement requires trying to move the technology base to a higher level from where it was at the beginning of the attempt. The business context of the individual performer must be taken into consideration when determining what is a technological advancement. The business context addresses the technology base of the company." The COMPANY X science reports quite clearly state how each project meets these criteria for technical advancement."

2. The draft SR&ED Technical Review Report on page 7 states: "The observation of the structural failures was on the boats used and delivered for a commercial, sport fishing operation and one can see the difficulties associated with instrumentation and data collection etc." Although not stated explicitly, this statement implies that the only way for valid sea trials to occur must involve detailed instrumentation testing and data analysis during the trial. It does not take into account the operating environment of the COMPANY X sea trials, or the business capacity of the company. The draft SR&ED Technical Review Report goes on to say that "this also limits the eligibility of the project as an SR&ED project". Such a conclusion represents a non-objective judgement of the quality of the SR&ED, which is outside the boundaries of a legitimate SR&ED claim review report, as outlined in the January 14, 2000 "Guide to Conducting a Scientific Research and Experimental Development Review" document (pp 7-8). It does not take into account that the COMPANY X projects were shop floor SR&ED. Furthermore, it implies that sea trials of sea-going experimental vessels do not rely on visual inspection as an important means for evaluating whether vessel performance meets design criteria. We suggest that any navel designer and/or builder, whether from academe or industry, would disagree with this premise.

3. The draft SR&ED Technical Review Report makes several references (pp 7, 9, 11, 12, and 13) to the sea trials implemented by COMPANY X as "common in the marine industry". Page 11 further states: "Sea trials are normally considered as part of the design process and as an acceptance tests and they do not satisfy the requirements of SR&ED." Such statements are a direct contradiction to the September 23, 2003 Guide Document "Recognizing Experimental Development" "Experimental Development Key Principles". Specifically, contrary to page 2 where it states: "Work that directly contributes to the attempt to achieve a technological advancement is experimental development regardless of what the work is called." The sea trials designed by Mr. Client were specifically established to determine whether the technological uncertainty of mechanical strength and structural integrity had been removed in the business shop floor SR&ED environment of the company. In the case of project 02-001 it turned out they had not; the original and subsequent design modifications failed. If the trials had been successful (as they were by 2004 year end), then they would have achieved a technically advanced eighteen foot aluminium boat design with a 10 year life-expectancy under continuous use in the BC Northern West Coast and the Queen Charlotte Island rough waters, at a cost that is acceptable to COMPANY X .

These statements further contravene IC 86-4R3, Section 7, paragraphs 7.1 – 7.3, pages 15-16; and the March 20, 2000 "SR&ED Project Definition - Principles and Q and A sheet for Project Definition Paper", pages 3-4 where the five steps for the development of a new or improved product are discussed. It states: "Variations do exist and are to be expected. For example, the third stage (c) is sometimes bypassed, and the 'prototype' is developed to meet project requirements or objectives. In some cases, the development may consist of systematically constructing a series of prototypes; each incorporating the lessons learned from earlier prototypes. The work in the first three stages (a, b, c) described above will constitute a SR&ED project. Activities that fall under d or f can also contain eligible work. A key issue is whether there is a scientific and/or technological uncertainty to overcome." This document goes on to say: "The end of a SR&ED project is defined as that point at which the scientific and /or technological uncertainties related to the previously defined scientific and/or technological objectives are resolved or are deemed to be unresolvable within the business context of the company." Finally, it states: "If the primary objective of the SR&ED project is to make further scientific and/or technological advances in the product or process, then the work is still part of the SR&ED project. If, on the other hand, the technological character of the product or process is substantially set, and the primary objective is to develop markets, to do pre-production activity, or to get a production or control system working smoothly, then the work is no longer part of the SR&ED project. However, if scientific and/or technological uncertainty exists under these circumstances, then work on studies to resolve the scientific and/or technological problems may still be part of the SR&ED project."

The five science reports in the COMPANY X SR&ED claims clearly state the technological objectives for each of the projects; the current state of the art of the technology; and the technological advancement sought. They clearly articulate, and go on to identify the technological uncertainty to be overcome to achieve the technological objective. They clearly state the technical plan and approach that was followed in each project, including planned trials to determine whether the technological uncertainties had been resolved. Each project clearly demonstrates how it falls within the five-stage process envelop for the development of new or improved products in a shop floor SR&ED business environment.

4. The draft science report makes reference to the fact that since the product was guaranteed, there was no technological uncertainty (p 4). It states: "the fact that the product is guaranteed seems to imply that there were no technical uncertainties involved with the product."

This statement contravenes IC 86-4R3, Section 7, paragraph 7.3, page 16: "Neither financial indicators (such as first sale) nor the issuance of warranties alone, for example, are adequate to mark the point of demarcation between experimental development and commercial production." Furthermore, it has been a well-established accepted fact between industry, the courts, and CRA that whether or not a product guarantee or warranty is in place is not a deciding factor in establishing whether or not technological uncertainty (and therefore SR&ED) exists. The offer of a warranty or guarantee is a business decision, and is not relevant in establishing whether technological uncertainty exists in the design and development of the technology in question. What is important is the work the company did, and what technological uncertainties it knew existed at the time the work was done[47].

There are other several aspects of this statement that are not valid or consistent with what transpired. The COMPANY X science report 02-001 quite clearly states that previous boat designs he sold had serious problems (pp 1, 2 background information). Pages 4 and 5 of this report present the current state of the art and the technological uncertainties faces. These facts were confirmed during the February 8th meeting. Mr. Client's reply to a question that "he did not expect structural problems" cannot be an accurate representation of the actual situation at the time. He clearly stated in the meeting that "these were prototype boats and the Lodge managers/owners knew this fact". In his words "No competitors have a boat design that works in these conditions." It is very possible he either did not understand the context of the question asked, or his response was a reflection of what he "hoped" would occur. In either case, it has been clearly stated in the science report, the site visit and the activities that transpired over the two sea trial years that COMPANY X had not achieved the objectives stipulated, and that technological uncertainty existed regarding the experimental boat's ability to structurally and mechanically withstand the continuous pounding of the waves in the BC Northern West Coast and the Queen Charlotte Island rough waters.

The draft SR&ED Technical Review Report states on page 4: "The R&D claimed seems to start with the failures experienced during the year 2002. However, the replacement cost of the boats during 2002 seems to be a commercial obligation related to commercial uncertainty. These statement ignores completely the state-of-the-art and the technical challenges (uncertainties) given in the COMPANY X 02-001 science report. These statements are contrary to Application Policy SR&ED 2002-02R2; Experimental Production and Commercial Production with Experimental Development Work - Allowable SR&ED Expenditures; July 29 2005. On Page 4 it states: "For the purposes of this paper, experimental production is defined as follows:

  • EP means the output of experimental development that is required to verify whether the technological objectives have been met and/or if a technological advance is achievable.

And

  • The purpose of the trial is to evaluate the technical aspect of the project. This is determined on the basis of the technical considerations and evidence relating to the particular trial (see below). Accordingly, the resulting sale of the EP is normally only incidental or secondary to the carrying out of ED work.

EP may be necessary, for example, to document and/or demonstrate that technological advancements are achievable in a commercial setting and to further resolve technological uncertainties, and evaluate the SR&ED project.

Experimental production may occur in the following situations:

A) When the SR&ED involves the development of a new product, process or equipment or the improvement of existing materials, devices, products or processes in a commercial facility, e.g. trial production runs from an improved line;"

Each of the science reports clearly stated its technological objectives, the technological advances sought, the technological uncertainties faced, and the technological advancement achieved. A systematic investigation was set and carried out that included a plan for sea trials that fit within the confines of the COMPANY X business environment and the operational environment of the boats. Whether or not the each of the project's development process meets the rigorous requirements for academe is irrelevant; it met the requirements for SR&ED as laid down in 248(1) paragraph (c) as interpreted through IC 86-4R3, section 2.11 Application of Criteria (pp 6-7). More specifically, paragraph 2.14: "In summary: If the primary objective is to make further technological advancements in the product or process, then the work meets the criteria for experimental development. If, on the other hand, the technological character of the product or process is substantially set, and the primary objective is to develop markets, to do pre-production activity, or to get a production or control system working smoothly, then the work no longer meets the criteria. However, if technological uncertainty exists under these circumstances, then the work on studies to resolve the technological problems may still be eligible. This is amplified in later sections." For each project, the technological character of the boat was not substantially set, and the primary objective was technically driven; they were not pre-production activities, but experimental development production boats built for sea trials in the actual extraordinary shop floor operating environment of their intended use. Of course, the intent of the experimental boat was a commercially viable specific boat design that could meet market requirements and deliver commercial benefits; this does not invalidate the work as being SR&ED.

6. The draft SR&ED Technical Review Report states on page 3: "(YYYY) is not a naval architect" and "COMPANY X did not consult classification societies". In the context of the COMPANY X business environment, neither of these facts is relevant, and they imply that the COMPANY X work does not qualify as SR&ED as it was not done by "qualified people" following an acceptable design process. On page 3 your report goes on to say: "Client said that his design tool was the environment and that he looks at the harsh conditions of the Queen Charlotte Island, and he studies various existing boats, increased the freeboard, changed some of the angles, lines of the boat geometry, etc. He moved the depth of the propeller by gut feeling he said. The new plate thickness is taken from the existing and well operational boats in the location. Client said that he studied the structural frames of everybody else's design. He claims that this is research from a practical perspective."

Mr. Client has more than 25 years of applicable boating industry experience, much of it in the Queen Charlotte Islands and off the Northern BC Coast. He has been exposed to recreational boat designs most of his life, along with the strengths and weaknesses of each. The "Cross-Sector Shop Floor Guidance Document" states on page 5: ""Trained or experienced personnel" does not mean that academic qualifications are necessary. Experience in the area of the technology is sufficient." In the February 8th meeting, Mr. Client clearly stated that he took the best aspects of other boat designs and coupled these with his own practical experience to develop his experimental boat designs. It was clearly stated in the February 8th site visit and the 02-001 science report that standard boat design concepts and tools were inadequate for designing a boat suitable for the waters off the Queen Charlotte Islands and the Northern BC Coast. This is validated by the fact that no boat builder has been able to economically design and build an aluminium boat that can stand up to the constant pounding found in these waters. Furthermore, he did consult with a structural consultant, and was advised by the metal expert that "in their opinion" the 3/16 inch aluminum "should be adequate" (which sea trials proved wrong). The reason Mr. Client was ultimately successful in 2004 with the 18 foot boat design was because he based his designs on many years of observation and practical experience, rather than theoretical models that has proven not to work for this specific environment. These activities fit well within IC 86-4R3 paragraph 2.11 (p 6) which states: "The judgement as to eligibility should be made within the context of a single company and its field of business. Specifically, the activities undertaken to resolve technical uncertainties are eligible if the taxpayer cannot obtain the solutions through commonly available sources of knowledge and experience in the business context of the firm. We expect that any firm claiming expenditures for scientific research and experimental development activities will have or will access the expertise necessary to carry out a viable program."

7. The draft SR&ED Technical Review Report states on page 3: "Client said that in less than 30 operational days the boats failed. However, there is no record of these failures, but he said that COMPANY X changed the design of the transom of these boats." On Page 4 the report goes on to say: "However there is no record of which structural elements failed, and the work done to correct the problem." The "Guide to Recognizing Experimental Development" issued September 23 2002 states on page 5: "Experimental development must be a systematic investigation or search by experiment or analysis. The existence of a process for doing the work will normally demonstrate the requirement of a systematic investigation or search has been met. The business or operational context of the company is a major factor in the decision of whether the process followed was a systematic investigation.

Any one of the following is indicative of the existence of a systematic process:

  • the work is carried out or led by trained or experienced personnel;
  • the work is conducted under a development protocol or under the direction of a project manager;
  • the work is documented; or
  • the process by which the work is performed is documented.

Even if these are not present, there may be other equally valid indicators of a systematic investigation."

As noted in the February 8th site visit, written documentation for the projects is sparse. The "Guide to Supporting Technical Aspects", dated August 12 02, page 3 states in part: "Examples of these records and documents which may exist in paper, or electronic, or any other media storage form include:

  • photographs
  • prototypes
  • physical samples
  • scrap

"In the case where further clarification of a SR&ED claim is requested by the CCRA, claimants may have many existing alternatives to support their claims. These alternatives may take the form of documents (some of which are mentioned in the preceding paragraph), discussions or interviews, or prototypes, or new or improved products or processes. It is recommended that both claimants and the CCRA be open-minded when selecting methods to support a claim."

Mr. Client created a time line for the work that went on from the site logs at the different lodges (see attachment 1), which was forwarded to you on March 17, 2005. Mr. Client presented several photographs that illustrate the cracking problems that occurred. Furthermore, he showed the CRA review team a boat under construction that follows the current commercial design established at the end of the 2004 trials, so they could see for themselves the changes implemented, which were pointed out by Mr. Client. Finally, all claimed boats are available for visual inspection in Prince Rupert to view where the failures happened, and what repair activity was implemented on each boat. Mr. Client has photographs showing examples of the structural problems, and the boats in storage. It therefore cannot be stated that there is no supporting evidence for the claims. The actual point in time of each failure is irrelevant; what is relevant is the fact that the failures occurred over the course of the COMPANY X sea trials, leading to advancement in their knowledge base, ultimately cumulating in a successful commercial design that is technically advanced to meet the requirements of the actual operating environments. The fact that the original drawings were over-written means only one aspect of the evidence has been lost; this does not render the claim ineligible. The fact that the timeline of activities had to be created from the fishing lodge managers' log books does not invalidate the fact that systematic investigations involving sea trials were conducted.

8. The draft SR&ED Technical Review Report on page 13 states: "The Company applied the state of the art knowledge available or acceptable to them and designed a series of boats." "All of these activities claimed as SR&ED are seen as direct application of commonly known boat design principles. All testing are seen as acceptance testing common to the marine industry."

"The work is seen as a direct application of engineering knowledge and there is no tangible systematic testing and claimed uncertainty is within the uncertainty normally experienced in the design of marine vehicles. There seems to be no eligible SR&ED activity in the claimed projects. The projects do not satisfy the requirements of SR&ED. The uncertainties seem to be mainly commercial rather than technical uncertainty."

These statements strongly indicate that the draft SR&ED Technical Review was conducted from the broad navel ship building perspective that does not take into account individual circumstance or unique shop floor SR&ED situations. The statement "claimed uncertainty is within the uncertainty normally experienced in the design of marine vehicles" acknowledges that there was technological uncertainty in these projects.In SR&ED there are no degrees of technological uncertainty; there is either technological uncertainty or there is not. Furthermore, the statements confuse following good engineering practices with the presence of the three SR&ED criteria as given in 86-4R3. Following good engineering practices is an essential component of a systematic investigation; it is a very strong indicator that methodical problem solving processes and techniques were followed, and the project was not "random trial and error" work. It does not mean that there are no elements of technological uncertainty and technological advance. The fact that the draft SR&ED Technical Review Report accepts the claimed projects as "seen as a direct application of engineering knowledge" acknowledges that the projects were systematic investigations. That these projects did not follow a product development path (YYYY) is familiar with; one that he would have employed if he did the work himself does not negate fact that each project followed a systematic investigation. This was shop floor SR&ED at a level that may be outside his realm of practical experience; this is not sufficient cause to say it is not eligible shop floor SR&ED for COMPANY X.

These statements imply that the reviewer is evaluating the quality of the SR&ED, rather than whether there is technological uncertainty, technological advancement and technological content in the shop floor SR&ED context of COMPANY X. This has always been outside the bounds of the SR&ED review process. This type of review is not in accord with "The judgement as to eligibility should be made within the context of a single company and its field of business. Specifically, the activities undertaken to resolve technical uncertainties are eligible if the taxpayer cannot obtain the solutions through commonly available sources of knowledge and experience in the business context of the firm."

The fact that "The extensive pounding administered by these waters takes its toll in terms of mechanical and structural fatigue that cannot be overcome through standard boat design techniques." and "To date, all attempts by other boat builders had failed. Standard boat design techniques proved inadequate." clearly sets the bounds of the COMPANY X shop floor SR&ED environment. These were problems that were being resolved by the small company with limited resources; not a major ship building company where designing and building ships involves hundreds of thousands or millions of dollars. If techniques were used in the project that did not employ expensive metal and structural testing, but were "a systematic investigation that led to the resolution of the technological uncertainties, leading to technological advancement in the business environment of the waters off the Queen Charlotte Islands and the Northern BC Coast", makes the work eligible shop floor SR&ED. To say it does not violates a large number of the application guidelines and accepted standards for the review of SR&ED claims.

The "Guide to Conducting a Scientific Research and Experimental Development Review" dated January 14, 2000 states on page 3: "The consultant must have the credentials, relevant SR&ED experience and the appropriate security clearance needed to evaluate the scientific or technological work outlined in the claim, and is bound by the rules of confidentiality (see Chapter 3). An understanding of the business context of the claimant's SR&ED efforts is also essential. CCRA will not use consultants that are in a conflict of interest and requires that consultants that are hired declare all situations that could reasonably be regarded as constituting a conflict of interest (e.g. relationships with competitors, investment interest).

The Science Advisor is responsible for the management of the consultant and maintaining the objectivity of the review. The consultant's role is to provide an opinion on eligibility of the technical work claimed, drawing on their expertise in that field. In performing this role, they are to be governed by the principles of objectivity, fairness, and materiality. The regional science manager (Regional Science Manager) has overall responsibility for the technical component of the SR&ED reviews."

Early on during the on-site meeting on February 8, 2005 (YYYY) made it very clear to us that he does not have experience in an SME environment with the design and development of small pleasure craft, or the category of boat under review. A review of his credentials (YYYY) gives his research interests as: (YYYY) Further reading of this page makes mention of larger ship design research involving (YYYY) ships and their potential impact on small craft in the southern coastal waters between Vancouver Island and the Mainland. Admittedly, (YYYY) is well published on his areas of research interest; he is not at all published on the topic of small pleasure craft design of the type under discussion, or for their extraordinary applications such as the waters found off the Queen Charlotte Islands and Northern BC Coast.

Furthermore, the process outlined in this guideline was not followed. Page 9 states: "Before a consultant is contracted, the claimant should be advised. If the claimant has a concern regarding the consultant under consideration, this concern should be communicated to the Science Advisor. The Science Advisor and their management must endeavour to resolve the concerns raised by the claimant. The decision on consultant selection rests with CCRA's management." In this instance, no advanced notification was given that a consultant was going to be used; the RTA just showed up at the clients with the consultant. The (YYYY) did not issue a letter until June 30 2005 stating that a consultant was to be used in the project review, almost five months after the site visit. Such actions reflect inappropriate professional behaviour and are not in the spirit of the SR&ED programme. They are clearly outside the CRA's own guidelines.

In summary, the numerous references given as examples above from the "Draft SR&ED Technical Review Report" demonstrates that: it was written from a perspective with limited exposure to the SME boat building industry, the nature of the waters of the Northern BC Coast and the Queen Charlotte Islands; and was not conducted in accordance with many of CRA's own published guidelines and IC 86-4R3. The report appears to evaluate the quality of the SR&ED rather than the content of SR&ED. It appears to rely on academic credentials as a requirement for SR&ED work, overlooking the role experience can play in the process.

Failure to follow the numerous application guidelines cited in this letter reflects a biased and inflexible assessment that finds its basis in the world of academe, rather than the world of industrial shop floor SR&ED. The review is not objective, does not reflect the business environment of COMPANY X, and unfairly places extraordinarily SR&ED requirements on the claimant. As a consequence, it implies that no SME boat builder can qualify for shop floor SR&ED unless they are a qualified marine architecture, incorporate expensive and rigorous controlled environmental testing (full scale recording of the pressure loads on the structural elements), incorporate extensive instrumentation testing in the sea trials, and follow a documentation regiment typically found in laboratory settings. Such thinking completely undermines the whole spirit of the SR&ED programme, and is non-compliant with IC 86-4R3 section 2.11 Application of Criteria (pp 6-7).

I look forward to discussing these issues with (YYYY) in our meeting on August 30th.

Yours truly,

(Original Signed By)
William J. Robinson


Notes:

(YYYY) Material withheld at author's request.

1. It is worth noting that the SR&ED programme belongs to the Minister of Finance, not the Minister of the CRA. The CRA role is to administer the programme in a fair and equitable manner in accordance with the SR&ED programme objectives. [Return]

2. Reported to me through the former Partnership Committee (PC); this statement was reportedly made by CRA senior staff at a meeting with industry members of the PC in early 2006. [Return]

3. See for example: €œHow to Improve Canada's Scientific Research an Experimental Development Tax Incentive Program - Ideas from Industry; A Report Submitted to the Ottawa-Carleton Regional Innovation Forum by The Conference Board of Canada; Written by Jacek Warda; May 1998, P6.€ [Return]

4. This research would build on, but be much more extensive than, the work discussed in €œAn Evaluation of the Federal Tax Credit for Scientific Research and Experimental Development€ paper; Working Paper 2007-08; Mark Parson and Nicholas Phillips; September 2007. [Return]

5. SR&ED Tax Incentives in Canada: Recent Changes; Bob Hamilton, Director, Business Income Tax Division, Department of Finance, Ottawa, ON; Paper presented to the Conference on Government Recipes for Industrial Innovation, Vancouver, 20-21 October 1994. [Return]

6. Information Circular 86-4R2, "Scientific Research and Experimental Development", issues June 29, 1988, revised May 24, 1994 (IC86-4R3). [Return]

7. INTERPRETATION BULLETIN NO: IT-151; Scientific Research and Experimental Development Expenditures; revised August 16, 1993 (IT-151R4). [Return]

8. See, for example: Managing the SR&ED claim process: A process audit case study; William J. Robinson, Donald A. Lewis and Morley S. Lipsett; 10 May 1994 - Revised 11 February 2000; Based on an invited paper prepared for the 1994 Annual Tax Executives Institute Canadian Tax ConferenceHull, Quebec. [Return]

9. 1994 Report of the Auditor General of Canada, Chapter 32, Paragraphs 32.20, 32.21, 32.29, and Exhibit 32.3. [Return]

10. Taken from personal notes of the author. [Return]

11. 1994 Report of the Auditor General of Canada, Chapter 32, Paragraphs 32.79 and 32.80. [Return]

12. 1994 Report of the Auditor General of Canada, Chapter 32, Paragraph 32.39. [Return]

13. See for example: Scientific Research and Experimental Development Tax Incentives: Renewing the Partnership Through Consensus, Consistency and Predictability: Submission to The Honourable Herb Dhaliwal Minister of National Revenue May 1998; Canadian Advanced Technology Association (CATA) in association with: the Aerospace Industries Association of Canada (AIAC); Alliance of Manufacturers and Exporters Canada (AMEC); Canadian Chemical Producers' Association (CCPA); Canadian Manufacturers of Chemical Specialties Association (CMCSA); Canadian Vehicle Manufacturers' Association (CVMA); Information Technology Association of Canada (ITAC); and B.C. Technology Industries Association (TIA). [Return]

14. 2000 Report of the Auditor General of Canada, Paragraph 6.59. [Return]

15. 2000 Report of the Auditor General of Canada; April 11, 2000; Paragraph 6.8. [Return]

16. See for example: SR&ED Program Renewal: A metric for Tracking Progress in the Telecom and Software Sectors: Indices and 1999 Survey; CATA Alliance; Issued Feb 2000; Authored by Dr. J. R. Russ Roberts. [Return]

17. Patterns of R&D Tax Claims in Canada 1992-93: Where the money went...;by Gerry Goodchild, Revenue Canada, Ottawa, and Morley Lipsett, Simon Fraser University Center for Policy Research on Science and Technology, Simon Fraser University, Vancouver, BC; Paper presented to the Conference on Government Recipes for Industrial Innovation, Vancouver, 20-21 October 1994. [Return]

18. CASHING IN ON FEDERAL INNOVATION INCENTIVES FOR RESEARCH AND DEVELOPMENT: A PROVINCE-BY-PROVINCE SCORECARD: Tax Executives Institute BC – Provincial Government Liaison Meeting, 28 May 1997; prepared by Morley Lipsett, PhD; Institute for Business and Innovation Studies, Simon Fraser University, Vancouver, BC. [Return]

19. Information Circular 86-4R3, "Scientific Research and Experimental Development" May 24, 1994; Para 2.11. [Return]

20. See for example: €œHow to Improve Canada's Scientific Research an Experimental Development Tax Incentive Program - Ideas from Industry; A Report Submitted to the Ottawa-Carleton Regional Innovation Forum by The Conference Board of Canada; Written by Jacek Warda; May 1998, P6.€ [Return]

21. 1994 Report of the Auditor General of Canada, chapter 32, Paragraph 32.50. [Return]

22. The detailed information would be used to establish overall quantified and qualified program benefits to demonstrate program objectives are being met. [Return]

23. Simon Fraser University's Center for Policy Research on Science and Technology (CPROST) is currently developing a certification science auditor course for the Canadian SR&ED ITC program. It will be launched in the fall of 2000. [Return]

24. The Federal System of Scientific Research and Experimental Development Tax Incentives:  [Return]

25. Renewing the Partnership Through Consensus, Consistency and Predictability; May 1998 by J. R. Roberts; P 6. [Return]

26. MESHING ACCOUNTING, TECHNOLOGY AND INNOVATION—evolution in Canada's R&D tax credit system, 1985-1994 by J.R. Roberts [Return]

27. Taken from a Revenue Canada presentation dated June 1998. Presentation given at the €œBuilding Partnerships€ conference June 26,27 1998.  [Return]

28. SR&ED Tax Incentives in Canada: Recent Changes, (Preliminary Draft), by Bob Hamilton, General Director, Financial Sector Policy Branch; October 1994. [Return]

29. How to Improve Canada's Scientific Research an Experimental Development Tax Incentive Program: Ideas from Industry. A Report Submitted to the Ottawa-Carleton Regional Innovation Forum by The Conference Board of Canada Written by Jacek Warda; May 1998; p 3  [Return]

30. The Federal System of Scientific Research and Experimental Development Tax Incentives: Renewing the Partnership Through Consensus, Consistency and Predictability; May 1998 by J. R. Roberts;  How to Improve Canada's Scientific Research an Experimental Development Tax Incentive Program: Ideas from Industry. A Report Submitted to the Ottawa-Carleton Regional Innovation Forum by The Conference Board of Canada Written by Jacek Warda; May 1998 [Return]

31. Speaking Notes for the Honourable Herb Dhaliwal Minister of National Revenue to the SR&ED Conference: Building Partnerships, Vancouver, British Colombia Saturday, June 27, 1998. [Return]

32. Formed in September 1998, the SR&ED Action Steering Committee is made up of 11 Industry Association Representatives and 7 Revenue Canada personnel. [Return]

33. Based on personal experience, experience of my clients, and feedback from other SR&ED ITC program users across the country. [Return]

34. €œGuide to Conducting a Technical Review: Scientific Research and Experimental Development Program€; march 1999  [Return]

35. Scientific Research and Experimental Development (SR&ED) Audit Information, March 1999 [Return]

36. Based on the public information available from Revenue Canada, the authors participation in two implementation steering Committee task forces, and discussions with knowledgeable practitioners from other industry sectors.  [Return]

37. Comparisons were made with the Automotive and Software Development industry sectors [Return]

38. INFORMATION CIRCULAR; €œScientific Research and Experimental Development; No. 86-4R2; August 29, 1988. [Return]

39. INFORMATION CIRCULAR; Scientific Research and Experimental Development; No. 86-4R3; dated May 24, 1994; P6 [Return]

40. INFORMATION CIRCULAR; Scientific Research and Experimental Development; No. 86-4R3; dated May 24, 1994; P7 [Return]

41. INFORMATION CIRCULAR; Scientific Research and Experimental Development; No. 86-4R3; dated May 24, 1994; P7 [Return]

42. INFORMATION CIRCULAR; Scientific Research and Experimental Development; No. 86-4R3; dated May 24, 1994; PP8,9 [Return]

43. The best example the author has seen is the €œScientific Research and Experimental Development: Administrative Guidelines and Application to the Automotive Industry (Consolidation of Topic Teams' Drafts). CATA is currently working on guideline benchmarks for the Information Technology sector. [Return]

44. The author's knowledge in this matter comes from his direct participated in the science audit process as a consultant to one of the Telecommunications companies.  [Return]

45. Is R&D more common than commonly thought?; Morley S. Lipsett; a discussion paper prepared for the Conference on Science and Technology Indicators and Benchmarks for Policy Analysis and Public Awareness, Simon Fraser University, April 1996. [Return]

46. IT-151R4; INCOME TAX ACT Scientific Research and Experimental Development Expenditures; August 16, 1993 [Return]

47. This point was made quite clear at the joint CRA - Industry November 23, 2004 €œ3rd Chemical Sector Workshop on SR&ED€ presented by members of the Partnership Committee SR&ED Tax Credit Chemical Working Group, in the examples discussed. [Return]