SR&ED Eligibility: Routine Engineering vs. SR&ED

September 27, 2024 Janette Conway

Routine engineering vs. SR&ED – The span of eligible SR&ED activities are likely broader than you think. (Photo Credit: ThisIsEngineering via Pexels.com)

The Scientific Research and Experimental Development (SR&ED) program provides one of the most lucrative tax credits for companies engaging in clear research and development, yet many companies that would be eligible don’t even bother applying, most often because they assume their project would not qualify. This post looks into one of the main sources of this misconception—the difference between routine engineering and SR&ED work. The span of eligible SR&ED activities are likely broader than you think.

SR&ED Eligibility in Engineering

SR&ED is defined for income tax purposes in subsection 248(1) of the Income Tax Act (ITA) as follows:

“‘scientific research and experimental development’ means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is

(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,

and, in applying this definition 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 […]”¹

To simplify, to qualify for the SR&ED tax credit, your company must actively engage in:

basic research
applied research
experimental development
design and engineering work that is commensurate and directly in support of any of 1, 2, or 3

The third and fourth criterion are of interest here. Experimental development can occur in engineering environments, and even if your company’s work includes standard engineering activities, it could still qualify for the SR&ED credit because sometimes companies do in-house engineering design while out-sourcing manufacturing services, and view the entire sequence of development as an engineering standard practice or “routine”. In the development of a new product, improvement to existing products or processes may have taken place if the whole project is viewed as one system with clearly defined overall technological goals. One of the main indicators that SR&ED has occurred is “technological uncertainty”, the first of the ‘Five Questions of SR&ED Eligibility‘.

The Five Factor Test

While no longer included within the CRA’s SR&ED policies, the “five questions” remain the standard for defining SR&ED when a dispute arises and it goes to the tax courts. We have discussed these questions in depth in our article “Are the Five Questions still the SR&ED standard?“. The five questions include:

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?²

SR&ED in Engineering

The CRA’s SR&ED Glossary defines engineering as:

“the practice of designing, composing, evaluating, advising, reporting, directing, or supervising the construction or manufacturing of tangible products, assemblies, systems, or processes that requires in-depth knowledge of engineering science and the proper, safe, and economic application of engineering principles.

By definition, and according to sound professional practice, engineering practice does not involve scientific or technological uncertainty and is thus not eligible on its own. However, engineering work that is commensurate with the needs and directly in support of basic research, applied research, or experimental development is eligible.

It is important to distinguish between work with respect to engineering and the work that engineers perform. Even though engineering practice is not eligible on its own, engineers can still be carrying out basic research, applied research, and experimental development.”³

As of April 24, 2015, the CRA removed the term “routine engineering” from the SR&ED Glossary. This is noted under the definition of “Engineering”:

Note
The following are the explanation of changes to this term as of April 24, 2015.

“routine engineering” was removed as there is no differentiation between engineering and routine engineering.

A paragraph was added to clarify that even though engineering practice on its own is not eligible, engineers could still be performing basic research, applied research, or experimental development.⁴

Interestingly, while the CRA defines engineering in the SR&ED Glossary as not involving scientific or technological uncertainty and thus not being eligible on its own, they have defined an entire section of engineering filed which can be selected at Line 206 in the SR&ED tax forms as the field of science or technology in the T4088 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim – Guide to Form T661:

2. Engineering and technology

Civil engineering

2.01.01 – Civil engineering

2.01.02 – Architecture engineering

2.01.03 – Municipal and structural engineering

2.01.04 – Transport engineering

Electrical engineering, Electronic engineering, and Information technology

2.02.01 – Electrical and electronic engineering

2.02.02 – Robotics and automatic control

2.02.03 – Micro-electronics

2.02.04 – Semiconductors

2.02.05 – Automation and control systems

2.02.06 – Communication engineering and systems

2.02.07 – Telecommunications

2.02.08 – Computer hardware and architecture

2.02.09 – Software engineering and technology

Mechanical engineering

2.03.01 – Mechanical engineering

2.03.02 – Applied mechanics

2.03.03 – Thermodynamics

2.03.04 – Aerospace engineering

2.03.05 – Nuclear related engineering (nuclear physics under 1.03.07)

2.03.06 – Acoustical engineering

2.03.07 – Reliability analysis and non-destructive testing

2.03.08 – Automotive and transportation engineering and manufacturing

2.03.09 – Tooling, machinery, and equipment engineering and manufacturing

2.03.10 – Heating, ventilation, and Air conditioning engineering and manufacturing

Chemical engineering

2.04.01 – Chemical engineering (plants, products)

2.04.02 – Chemical process engineering

Materials engineering

2.05.01 – Materials engineering and metallurgy

2.05.02 – Ceramics

2.05.03 – Coating and films (including packaging and printing)

2.05.04 – Plastics, Rubber, and Composites (including laminates and reinforced plastics)

2.05.05 – Paper and wood and textiles

2.05.06 – Construction materials (organic and inorganic)

Medical engineering

2.06.01 – Medical and biomedical engineering

2.06.02 – Medical laboratory technology (biomaterials under 2.09.05)

Environmental engineering

2.07.01 – Environmental and geological engineering

2.07.02 – Petroleum engineering (fuel, oils)

2.07.03 – Energy and fuels

2.07.04 – Remote sensing

2.07.05 – Mining and mineral processing

2.07.06 – Marine engineering, sea vessels, and ocean engineering

Environmental biotechnology

2.08.01 – Environmental biotechnology

2.08.02 – Bioremediation

2.08.03 – Diagnostic biotechnologies in environmental management (DNA chips and biosensing devices)

Industrial biotechnology

2.09.01 – Industrial biotechnology

2.09.02 – Bioprocessing technologies

2.09.03 – Biocatalysis and fermentation

2.09.04 – Bioproducts (products that are manufactured using biological material as feedstock)

2.09.05 – Biomaterials (bioplastics, biofuels, bioderived bulk and fine chemicals, bio-derived materials)

Nano-technology

2.10.01 – Nano-materials (production and properties)

2.10.02 – Nano-processes (applications on nano-scale)

Other engineering and technologies

2.11.01 – Food and beverages

2.11.02 – Oenology

2.11.03 – Other engineering and technologies⁵

This considerable list of engineering fields being listed as SR&ED eligible fields within a prominent SR&ED policy document is excellent proof that in fields of engineering, SR&ED eligible work may occur – so long as it’s structured as “Experimental Development”. Therefore, to qualify there needs to be work that falls under paragraph c) (Experimental Development) but there may be considerable engineering work that is “directly in support of and commensurate with the needs” of the experimental development work, per paragraph d) of the definition of SR&ED.

Engineering, SR&ED, or Both? What is “Routine Engineering”?

While the term “Routine Engineering” is not defined in the CRAs SR&ED policies or glossary, it still exists elsewhere. Further, disputes over whether work is “experimental development” or “engineering” are common, resulting in the CRA denying SR&ED claims carried out by engineering companies or within engineering environments.

Therefore, to understand whether a project is SR&ED or (routine) engineering, potential SR&ED claimants would benefit from a clear definition of the term “Routine Engineering”. The term has been discussed in detail across a multitude of different tax court rulings which we have reviewed in the next section in an attempt to parse out a clear definition of the term.

Aside from analyzing the details of each project based on the definition of SR&ED within the Income Tax Act (ITA), nearly all tax court judges turn to the landmark case of Northwest Hydraulic Consultants Ltd. v. The Queen (1998) for guidance and legal precedence. In this case, Justice Bowman put forth the following guidelines on how to determine the presence of routine engineering:

[16] […] 1. […] (b) What is “routine engineering”? […] Briefly it describes techniques, procedures and data that are generally accessible to competent professionals in the field.

[…]

3. […] (b) What may appear routine and obvious after the event may not have been before the work was undertaken. What distinguishes routine activity from the methods required by the definition of SRED in section 2900 of the Regulations is not solely the adherence to systematic routines, but the adoption of the entire scientific method described above, with a view to removing a technological uncertainty through the formulation and testing of innovative and untested hypotheses.⁶

Example Cases – Win & Loss

Mold Leaders Inc. v. The King (2023) – Loss

The Appellant in this case, Mold Leaders Inc. (ML), conducted a business of injection molding, computer numerically controlled machining and prototype injection molding for clientele including from the automotive industry. In this case, the Appellant sought to appeal the reassessments of their 2016 and 2017 taxation years made by the Minister of National Revenue (the “Minister”), who concluded that “the Appellant did not identify or encounter any technological uncertainty which could not be removed by the Appellant’s knowledge base”, and therefore denied the Appellant’s SR&ED claims.

In this case, the Judge reviewed the initial testimony of the Appellant’s primary witness, for evidence of technological uncertainties and then used the definition of SR&ED as written in the Income Tax Act, and the five-factor test, to determine if the Appellant’s research activities met the definition of SR&ED activities and that the expenses it incurred were deductible expenses for SR&ED and therefore eligible expenses for the calculation of the ITC.

The Appellant had retained the company National R&D Inc. as an expert witness for their case, however, because the individual from National R&D Inc. “did not have sufficient background in the plastic injection molding industry to be qualified as an expert in that industry”, he was not accepted as an expert and his expert report was not admitted into evidence.

The Judge determined the Appellant’s process was “indicative of routine engineering or standard procedures”, and that there was no technological or scientific uncertainty within any of the projects in question. The appeal was dismissed without costs.

You can view our full summary of this legal ruling here: Mold Leaders Inc. v. The King (2023)

Canafric Inc. v. The King (2023) – Win

The Appellant in this case (Canafric Inc.) was a food manufacturing business specializing in developing frozen pies. During the 2013-2016 taxation years, the Appellant carried on various projects and activities aimed at developing new or advancing pre-existing products. A portion of the Appellants’ SR&ED claim was reassessed and denied by the Minister of National Revenue (‘Minister’) and the expenditures related were denied. In this case, the Appellant appealed the Minister’s decisions arguing the work done in these projects did constitute as SR&ED within the meaning of subsection 248(1) of the Act.

In developing new products, Canafric had to balance “health” and “taste” requirements. Higher salt and fat contents generally lead to better tasting but unhealthier products. Throughout the Taxation Years and for every project, Canafric sought to reduce salt and fat contents in its products, while maintaining good taste. According to the Appellant, even if the ultimate goal was the same, the nature of this challenge varied from one product to the other because different ingredients do not interact the same way with fat and salt. This was a major source of disagreement with the CRA’s research and technology advisor (RTA).

The Judge used the definition of SR&ED as written in the Income Tax Act, and the five-factor test first posed by Judge Bowman within the case of Northwest Hydraulic Consultants Ltd. vs. The Queen (1998), to determine if the Appellant’s research activities within each of the denied projects met the definition of SR&ED activities and that the expenses it incurred were deductible expenses for SR&ED and therefore eligible expenses for the calculation of the ITC.

Based on the challenges described by the Appellant, each project in question posed a technological uncertainty which could not be resolved by routine engineering or standard procedures. The Appellant attempted to create recipes in order to meet client objectives for their products. Each project consisted of a new or improved product which meant there was no information available on how to achieve these goals. A major source of disagreement for all SR&ED Claims was the RTA’s position that each breakthrough was transferrable from one product to the other. For example, the RTA stated that salt and fat reduction techniques could be replicated in different products. The Appellant clearly demonstrated that this was not the case because the ingredients will react differently when used in different products. The Appellant was unable to achieve all of its targets. Nonetheless, the elimination of certain recipes which did not work constituted a technological advancement.

Based upon the evidence, which the Judge stated was “most compelling and met the burden put forth upon them by the pleadings”, the Appellant was able to successfully establish that the 2013-2016 SR&ED Claims met all five criteria established in Northwest Hydraulics and the appeal was allowed with costs.

You can view our full summary of this legal ruling here: Canafric Inc. v. The King (2023)

A Review of Related Legal Rulings

SR&ED begins when there is technological uncertainty present. In the case of Mold Leaders Inc. v. The King (2023), the judge determined that there was no uncertainty present. In addition, the approach the Appellant adopted to achieve their goals was not a systematic investigation or search but rather trial and error. The projects in question were determined to be routine engineering as the goal of the projects was not to overcome any technological uncertainties nor were there any resulting advancements.

In contrast, the judge analyzing the case of Canafric Inc. v. The King (2023) was able to determine that technological uncertainty was present across the Appellant’s projects claimed for SR&ED. The Appellant’s overarching goal across their projects, “to reduce salt and fat contents in its products, while maintaining good taste”, did have technological uncertainty present as different ingredients do not all interact the same way with fat and salt. The goal of the projects was to overcome this base technological uncertainty, and the approach adopted by the Appellant to overcome this uncertainty was consistent with a systematic investigation or search. In addition, even though the Appellant was unable to achieve all of its targets, the elimination of certain recipes which did not work constituted as technological advancement.

The CRA defines “advancement” in the SR&ED as:

[…] the generation or discovery of knowledge that advances the understanding of science or technology.⁷

We have discussed in more detail what technological advancement is and how it cannot occur if there is not first a technological uncertainty. See our article “Technological Advancement: The Core of SR&ED“.

These examples are only two of MANY legal ruling cases where there has been confusion about the difference between SR&ED and routine engineering. In the case of Formadrain Inc. v. The Queen (2017) Justice D’Auray further defined uncertainty in SR&ED by stating:

[93] In other words, the lacking knowledge must really not exist in the base of scientific or technological knowledge, not simply be unknown to the claimant.⁸

This support Justice Bowman’s statement that if the knowledge hoping to be obtained by the SR&ED claimant is generally accessible to competent professionals in the field then it “exists within the knowledge base” and attempting to learn it would be considered routine, not advancement.

In the case of Abeilles Service de Conditionnement Inc. v. The Queen (2014) Justice Jorré stated:

[142] It must be borne in mind that these criteria are used to help determine whether or not a technological advancement has occurred. The first criteria, technological uncertainty, is one way of dealing with the technological advancement criteria; there can hardly be a technological advancement if one already knows how to achieve the end result; the second and third criteria are, inter alia, one way of ensuring that the work was undertaken for the purpose of achieving technological advancement and that it was not, for example, an advancement achieved by accident rather than work undertaken for the purpose of achieving technological advancement.⁹

Justice Jorré emphasizes that in order for SR&ED to have occurred there must first be an uncertainty, which cannot happen if the knowledge already exists (is part of the knowledge base, and is accessible by professionals within the field). He also emphasizes that the work must be undertaken “with the purpose of achieving technological advancement”, which Justice Bowman also emphasized a need for within Northwest Hydraulic Consultants Ltd. v. The Queen (1998) when he stated “What distinguishes routine activity from the methods required by the definition of SRED […] is […] the adoption of the entire scientific method […], with a view to removing a technological uncertainty“¹⁰

In the case of Béton mobile du Québec Inc. v. The Queen (2019) Justice Lafleur analyzed a SR&ED claim to determine if the Minister of National Revenue erred in their denial that the claim was SR&ED. Justice Lafleur also used the terminology initially posed by Justice Bowman stating that knowledge “generally accessible to competent professionals in the field” is not SR&ED as the method used are part of the scientific or technological knowledge base:

[43] Therefore, creating a new product using techniques, procedures and data that are generally accessible to competent professionals in the field is not SR&ED even if there is doubt concerning the way in which the objective will be achieved. In other words, the mere fact that a product does not exist does not necessarily support the inference that its development involves technological or scientific uncertainty.¹¹

The second part of Justice Lafleur’s statement is a common area of confusion for potential SR&ED claimants. The creation of a “new” product does not automatically prove SR&ED occurred, SR&ED does not rely on the outcome of a tangible product. As stated in R&D PRO-innovation Inc. v. The Queen (2015):

[38] […] Novelty or innovation in a product is not sufficient to illustrate technological advancement.¹²

To reiterate, advancement is: “the generation or discovery of knowledge that advances the understanding of science or technology”.¹³
The type of knowledge necessary in the context of SR&ED is conceptual knowledge, such as theories or prediction models, not simply factual knowledge, such as data or measurements.¹⁴ New technological knowledge may end up being incorporated in the new or improved materials, devices, products or processes of the company, however it is not the product produced from the process that matters, rather the knowledge produced.

The cases of Buhler Versatile Inc. v. The King (2023), and Dave’s Diesel Inc. v. The Queen (2022) are two of many more recent examples of SR&ED vs. routine engineering that may also be beneficial to review.

Routine Engineering Defined

Although the distinction between engineering and routine engineering was removed from the SR&ED Glossary, it is still important to be able to know the difference as it has been a commonly used reason for the CRA to deny SR&ED claims carried out by engineering companies, or SR&ED claims carried out within engineering environments, stating that the work involved was not SR&ED but rather “routine engineering”. It is confusing that the CRA does not define the term but continues to utilize it. It is further confusing that they state “engineering practice on its own is not eligible” but then define over 50 engineering fields of science or technology in the T4088 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim – Guide to Form T661.

As evidenced in the case of Canafric Inc. v. The King (2023), the CRA makes mistakes too. The Appellant was able to prove through the use of their supporting documentation and a knowledgeable expert in the field of SR&ED conducted that they did meet all five requirements and thus the CRA’s denial of the Appellant’s SR&ED claim was revoked.

After examining the above legal rulings we can deduce that “routine engineering” is defined with the tax court to mean that the techniques, procedures and/or data utilized during the work are generally accessible to competent professionals in the field. If this is the case, then the related knowledge base does not contain uncertainty and therefore it will not truly be advanced. The key lesson to be learned from all these cases is that if your work meets all five requirements of the five factor test, and you have ample evidence to stand behind your claims then you have no reason to wonder whether your work is routine engineering or SR&ED.

Conclusion

It is important to distinguish between routine projects and SR&ED project activities. To carry out SR&ED projects, one must seek to overcome technological uncertainties for the purpose of making technological advancements. This must be approached through a systematic investigation or search. Many activities, such as installation of new equipment, standard testing, automation of process or engineering design practices would be considered as routine. As well, there are some activities clearly described as non-eligible by legislation, such as routine testing and manuals creation.

Be sure you and your team are well versed on the SR&ED terminology available on the CRAs SR&ED Glossary and SR&ED Policies, and that you have THOUROUGH understanding of what constitutes as “uncertainty” and therefore “advancement” for the purposed of SR&ED. We have written a few helpful articles on the subject:

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SR&ED Eligibility: Routine Engineering vs. SR&ED