Scientific Research and Experimental Development tax incentive program litigation (SR&ED Litigation)

The starting point with all tax matters is the Income Tax Act, which prescribes the computation of income for tax purposes, and the assessment of tax by the CRA. The ITA also governs the process for objections to assessments by taxpayers, and the procedure for appeal of CRA decisions to the Tax Court – and in some cases, ultimately the Supreme Court of Canada.

SR&ED stands for “scientific research” and “experimental development” which are different categories of spending activities which entitle the taxpayer to an additional refundable credit – unlike most expenses which just reduce the amount of the taxpayer’s income and hence tax payable. Claiming SR&ED expenses is similar to general income tax matters with the exception that to claim a SR&ED, a taxpayer files a special form claiming SR&ED with their tax return. It the SR&ED expense is allowed, the credit entitles the taxpayer to a refund even if no tax is otherwise payable. SR&ED credits can return money to the hands of the taxpayers.

A special group of auditors in CRA with technical expertise review SR&ED claims. Usually the taxpayer has a chance to deal with auditors when some or all of a taxpayer’s claim is disallowed to provide additional information or explanation. If the matter is not resolved with the auditors, the next stage is filing an appeal (notice of objection) for an independent review by CRA of the auditor’s decision. If the appeals officer dismisses the taxpayer’s notice of objection (notice of confirmation) that decision can be appealed to the Tax Court of Canada. Both CRA and the taxpayer can appeal the Tax Court decision to the Federal Court of Appeal and ultimately to the Supreme Court of Canada, in some cases

The definition of SR&ED in the ITA falls into three broad categories – basic research, applied research, and experimental development. The first two components usually have a scientific component and the third generally does not – however, people often get confused by the SR&ED nomenclature and assume all activities must have a scientific component, which is not the case. Taxpayers who perform eligible SR&ED are generally entitled to a tax credit in the form of a payment TO the taxpayer which differs from most other tax matters where taxpayers are required to pay tax, as the SR&ED program was designed as an incentive for taxpayer’s to take risks, so CRA is vigilant in auditing SR&ED claims as they involve what is considered a “tax expenditure”. The ITA is a patchwork quilt of revenue collection and social policy, the SR&ED falls towards the policy end of the spectrum, and designed to incentivize taxpayers to perform certain types of activities (e.g. like exploring for minerals, drilling for oil).

Case law has built up around the evidentiary requirements for each form of SR&ED – as the end result is fundamentally different depending on whether the taxpayer performs basic research, applied research or experimental development. To use an example – basic research might involve commercial application of static electricity (i.e. the invention of the photocopier). Experimental development on the other hand might involve research on how to improve the performance of an existing photocopier. The taxpayer has the burden to show that their work is in fact SR&ED – as opposed to say routine engineering or product improvement, etc. The evidentiary burden varies for each type of research and in many cases requires the input from experts – to opine on whether particular work – e.g. software development, creating a new computer game, etc. meets the SR&ED definition and whether the taxpayer has met the evidentiary burden of meeting the criteria for SR&ED.