New SR&ED Policy: Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives
On August 13, 2021, the Canada Revenue Agency (CRA) announced a new scientific research and experimental development (SR&ED) policy document: Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives. This document replaced the Eligibility of Work for SR&ED Investment Tax Credits Policy which has been archived. This post will examine the new policy and summarize any changes from the prior policy. It will also explain how this new policy may impact claims now and in the future.
What’s new in the policy?
The What’s new – SR&ED Program page states, “provide clearer and simpler information about how SR&ED work is defined under the Income Tax Act. This will make it easier for businesses to assess whether their work is eligible for SR&ED tax incentives at the outset, before they apply.” The new policy is aimed at simplifying the information about the SR&ED program which can often feel intimidating with the particular jargon it uses and the complicated policies which govern it.
The Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives policy is now broken into two sections to determine SR&ED eligibility: “Why” and “How”.1 The old policy was broken into: “Step1: Determine if the work meets the definition of SR&ED” and “Step 2: Determine the extent of eligible work”. The new policy explains that both the “Why” and the “How” must be met for work to be eligible for SR&ED.
The “Why”
The Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives policy states:
Work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement (contained in paragraphs (a) to (c) of the definition). The key to both is the generation or discovery of knowledge that advances the understanding of science or technology. The type of knowledge in this context is conceptual knowledge, such as theories or prediction models, rather than just factual knowledge, such as data or measurements.1
This has been a foundation of SR&ED and shows that if there is not an advancement, the work is ineligible, regardless of the type of work being accomplished. Advancements do not need to be major discoveries and incremental advancements qualify for SR&ED.
The policy also explains how to determine if new scientific or experimental knowledge is required:
It is needed when it is unknown (or uncertain) whether a given result or objective can be achieved, due to an insufficiency in the available scientific or technological knowledge. This is referred to as a scientific or technological uncertainty. Note that the available knowledge is the combined scientific or technological knowledge of the resources within your business and those sources that are reasonably available to you publicly.1
This explains what is also known as the technological uncertainties (Line 242 on the T661) that must be overcome by the SR&ED work. It also explains the knowledge base that must be established to determine if the knowledge is publicly available. The knowledge base and uncertainties are considered the starting point of SR&ED. The scientific and/or technological uncertainties must be addressed, not circumvented, for the work to be eligible.
The “Why” requirement in the context of experimental development
Experimental development is often done with the goal of technological advancement. The policy further explains:
When developing new or improved materials, devices, products or processes, problems can occur when there is a need to achieve a set of features, functions or capabilities, while being restricted by a set of constraints. When the technological knowledge available to your business is insufficient, attempting to resolve these problems through experiment or analysis will result in the generation of new technological knowledge.
Here are some characteristics of problems that may suggest the technological knowledge is insufficient:
- Existing design methods are not applicable;
- Requirements or specifications do not conform to existing standards;
- Too many variables or unknowns;
- Parameters or conditions are outside of the normal operating range;
- Nature of the problem is evolving;
- Data is not readily available;
- There are interlocking constraints.
Sometimes there is little doubt that a product or process can be developed when cost targets are not a barrier. In commercial reality, however, a reasonable cost target is always an objective. Although such cost targets on their own do not create technological uncertainty, trying to meet them might. Thus, a technological uncertainty may arise that is imposed by economic considerations.4
Many times corporations are attempting a business objective to improve upon or develop a new product or feature. This explanation illustrates how a business objective can be viewed as SR&ED and uncertainties and limitations that are common.
Additionally, the policy also explains that learning is not SR&ED:
Acquiring available knowledge or know-how, for example, through training, on-the-job learning, hiring expert employees or consultants, or by purchasing proprietary knowledge does not meet the requirement of attempting to achieve technological advancement.5
The “Why” requirement in the context of scientific research
Basic research and applied research are both eligible SR&ED categories. Basic research is defined as, “Basic research is carried out to advance scientific knowledge without a specific practical application in view. The intent is to expand the existing scientific knowledge base.”. Applied research is defined as, “Applied research is also carried out to advance scientific knowledge, but with a specific practical application in view.”.5
The policy further explains:
In the context of scientific research, both basic and applied research are categories of work that are conducted for the generation or discovery of knowledge that advances the understanding of science.
When it is uncertain whether a given result or objective can be achieved, due to an insufficiency in the available scientific knowledge, then further scientific study through experiment or analysis will result in the generation or discovery of this scientific knowledge.
Given the similarity between experimental development and applied research, both having an application in view, many of the characteristics of experimental development discussed above will also extend to applied research.5
The “How”
The policy also states that the work must be systematic as contained in the definition of SR&ED and that while many businesses follow their own practices, and while these are often systematic it may not be enough:
It is important to distinguish between a systematic approach to carrying out work and the approach that is a systematic investigation or search called for in the definition of SR&ED. The latter approach includes:
- Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving your objective or resolving your problem. Your idea may be expressed as a possible solution to a problem, a proposed method or an approach. This can be referred to as a hypothesis.
- Testing of the idea or hypothesis by means of experiment or analysis. The idea can evolve and change as a result of testing.
- Developing logical conclusions based on the results or findings of the experiment or analysis.
- Keeping evidence that is generated as the work progresses.5
Describing your hypotheses, the testing of the hypotheses, and conclusions of the work are all written in Line 244 of the T661 when your SR&ED investment tax credit (ITC) claim is submitted. Documentation (evidence) is in Lines 270-282. While documentation is not submitted with a claim, it is important to maintain documentation in case your claim is subject to a review or audit by the CRA. The policy further explains:
what is required is that the work be conducted for the purpose of advancing the understanding of technology, given there is an insufficiency of technological knowledge to achieve your objective. This new technological knowledge can be incorporated in the new or improved materials, devices, products or processes, and is often represented by the technological know-how, methodologies or techniques gained. Technological know-how includes the knowledge of how various constituents are embodied within the materials, devices, products or processes, and work together to meet your objective.5
Has the definition of SR&ED changed?
The first item addressed in the new policy is the definition of SR&ED which remains unchanged in the Income Tax Act. This is a critical item to remain unchanged, as work is required to meet the definition of SR&ED which is defined in the Income Tax Act and Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives as:
“scientific research and experimental development” means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or
(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,
and, in applying this definition 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
What work is considered support and what is excluded?
The policy provided a definition of support work and the categories eligible:
Paragraph (d) work in the definition of SR&ED is commonly referred to as support work. This work must be with respect to one of the following eight categories:
- Engineering
- Design
- Operations research
- Mathematical analysis
- Computer programming
- Data collection
- Testing
- Psychological research5
The policy also explains that support work is still eligible to be submitted with the SR&ED claim:
Support work is not SR&ED on its own.However, it can be part of the SR&ED if it is commensurate with the needs and directly in support of basic research, applied research or experimental development work that is undertaken in Canada.5
Certain work is also excluded from SR&ED eligibility and is considered excluded work and cannot be claimed. The policy explains:
Certain work is specifically excluded from the definition. Excluded work is identified in paragraphs (e) to (k) of the definition of SR&ED, namely:
- Market research or sales promotion
- Quality control or routine testing of materials, devices, products or processes
- Research in the social sciences or the humanities
- Prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas
- The commercial production of a new or improved material, device or product, or the commercial use of a new or improved process
- Style changes
- Routine data collection
Collectively, these paragraphs are referred to as the exclusions. This work cannot be claimed.5
What has been removed from the policy?
The new Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives policy has removed some critical pieces of information that were in the old Eligibility of Work for SR&ED Investment Tax Credits Policy – 2015.
Examples
The old Eligibility of Work for SR&ED Investment Tax Credits Policy – 2015 had six examples in it to illustrate technological uncertainties, technical problem versus technological uncertainty, cost targets leading to technological uncertainty, development based on existing scientific or technological knowledge, creating new materials, devices, products or processes without technological advancement, and commensurate with the needs and directly in support.
These examples made it clear to taxpayers what was eligible SR&ED work and how to describe it on their T661. The new policy does not provide examples and is less specific on what the CRA considers eligible. This will make it harder for those filing claims with the CRA and determining if their work is SR&ED eligible.
Technical uncertainty vs. technical problem
The new Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives policy does not specify the difference between a technical problem and technological uncertainty. This is an important distinction when determining if work is SR&ED eligible. Not all technical problems contain technological uncertainties, therefore, not all technical problems are SR&ED eligible. Technical problems can be resolved with existing knowledge and solutions. Technological uncertainties cannot be resolved using the existing knowledge base.
The Five Questions of Eligibility
In the example of the old Eligibility of Work for SR&ED Investment Tax Credits Policy – 2015, it states that “We cannot determine eligibility without understanding the work performed and evaluating it using the five questions.”.
- Was there a scientific or a technological uncertainty?
- Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
- Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
- Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
- Was a record of the hypotheses tested and the results kept as the work progressed?14
These questions have been used as legal precedence when determining if work is SR&ED eligible since 1998 and were incorporated into the policies starting in 2012 and continuing in 2015. It is not clear as to why they have suddenly been removed from the policies as Tax Court of Canada (TCC) judges are using the landmark case to determine eligibility to this day. Are the five questions no longer relevant to SR&ED? Will they be continued to be used in the TCC? The new policy does not address any of these questions or concerns.
Two-step methodology to determine if work meets the definition of SR&ED
The old Eligibility of Work for SR&ED Investment Tax Credits Policy – 2015 contained a two-step methodology to determine if work meets the definition of SR&ED. Step 1 was “Determine if there is SR&ED” and the five questions from above were used to make this determination. Step 2 was “Determine the extent of eligible work”.14 It appears as though this two-step process has been replaced by the “Why” and “How” in order to simplify the definitions. Support work and excluded work explained in Step 2 of the old policy are now listed under “Categories of eligible work”.
Conclusion
In addition to this new policy the CRA updated Claim SR&ED tax incentives – What can you claim that walks taxpayers through the claim process in four sections. We will summarize this page in a future update.
The new Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives policy came as a surprise to many SR&ED stakeholders. It is uncertain as to what happened to the Five Questions of Eligibility? Will these still be used to determine SR&ED eligibility as they are still used as legal precedence in the Tax Court of Canada? How will this change eligibility? The definition of SR&ED in the Income Tax Act did not change so one would deduce that eligibility of claims already with the CRA should not be affected but right now everything is uncertain. By moving the SR&ED project information out of the policy and into the information page, it is no longer considered “CRA policy” – which makes its reliability for taxpayers uncertain. We will continue to update our readers with more information as it becomes available.