SR&ED (Scientific Research & Experimental Development) is the name of the largest, most important and most generous corporate tax incentive program in Canada. But in recent years, the program has shifted from an incentive program to a compliance program. Denials are far more common now than they were 5-6 years ago. By now, a large number of claimants have experienced a bad audit. It has been reported that there exists an unprecedented number of cases in the queue with the Tax Court of Canada, a clear indication of disagreement between claimants and CRA.
What can you do if you find yourself in this situation?
Let’s review your options.
First, you’ll need to understand whether your claim has been deemed ineligible or unsubstantiated. There’s a big difference.
Ineligible means that CRA believes that they truly understand the project, and evidence was provided, but the work does not meet with the definition of the Income Tax Act.
Unsubstantiated means that CRA does not believe they were given enough evidence in order to make a determination. This can be a perplexing ruling to many claimants, especially after they have provided gobs of seemingly relevant evidence to CRA.
If your proposal of denial was recently received, you should seek out a second opinion immediately. Whether you prepared your claim yourself, or used the services of a reputable consulting firm, a second opinion is the right choice. There’s a chance that CRA’s position is actually correct, and if so, it’s better to know before launching a lengthy and futile battle. There’s also a chance that your project was eligible, but the wrong evidence was provided. A professional SR&ED expert should be able to advise on these issues, and provide a sound opinion on eligibility.
Your claim could be deemed ineligible for a few different reasons: lack of technological obstacle, lack of technological advancement (which is basically the same thing), lack of systematic investigation, lack of documentation (which again is similar to the argument immediately prior) or a combination of all four. It’s important to understand the differences.
Many people (even supposed experts) believe that if they subjectively identify an advancement, perhaps an advancement for their business, and if the activities or nature of the project involves technology, then there must be a technological advancement, and therefore the company or SR&ED consultant believes that the work is eligible. A common example of this – a company needs a new machine. The new machine is more efficient, more productive, and innovative – no one else has developed such a machine. The machine is a piece of technology. Therefore, the company claims SR&ED. This argument does not suffice, and the chance of denial based upon only these factors is very high.
You need to determine whether a technological obstacle or uncertainty exists. This is best understood as a technological problem for which a true experiment is required. Standard practices and available knowledge cannot be predictably or readily adapted to resolve the issue. There are usually constraints or limitations that render the standard approaches inapplicable.
All the policy issues cannot be covered here, the knowledge base on these issues is immense, so make sure you talk to an expert that is familiar with every argument that CRA has thrown at you.
Your path to success
On to your practical options. If you have just received a proposal of a denial, you still have time to salvage your case without going to appeals. This could take the form of written arguments or more evidence.
Your case could also be escalated to SR&ED management, if the rationale behind the denial is itself unsubstantiated (ie. it’s not SR&ED because we said so). An SR&ED Manager should listen to your grievance, and may agree to postpone your denial processing, giving you an option of another meeting where issues can be discussed. Many cases are resolved at this stage, new evidence is identified, or CRA changes their opinion on eligibility due to your arguments.
If the escalation to management is not successful, you can escalate to the Assistant Director. This is where it’s very valuable to have a knowledgeable expert by your side. A reputable practitioner is more likely to have success with reaching out to senior management. In any case, you are effectively asking for a Second Administrative Review, which will only be granted if you can demonstrate that the SR&ED Reviewer did not follow procedure. This can be difficult to prove, as CRA Reviewers are trained to follow the book, even if they are denying your claim for improper reasons. Most requests for Second Administrative Review are denied.
If all your efforts of escalation don’t work, you can go to appeals. It’s important to understand what “appeals” really means, however. This is a CRA body providing a second opinion on the findings of their own employees. If your case involves a very clear cut error, they may be willing to grant your appeal. You need to provide evidence, cite policy and the Income Tax Act. More often than not, however, the appeals branch upholds a CRA denial. And this process can take up to 2 years.
The most compelling aspect of this whole process is the Tax Court of Canada. You can by-pass Appeals and go straight to Tax Court. Well, kind of. You must first file a Notice of objection, wait 90 days, and then you can file with the TCC. This is your best chance at justice if your case was found to be ineligible based upon a standard practice / routine engineering argument, or unsubstantiated.
The Tax Court judge looks at your case based upon the “balance of probabilities” which is a much lower bar than CRA uses during an audit. A Judge is not a technologist and takes a common-sense approach to eligibility. He or she will be familiar with the “the spirit of the legislation”, that is, SR&ED is as an incentive program, whereas CRA sees SR&ED as a compliance program. He or she will be interested in comparing your work to that which was known in the public domain. A judge looks at evidence in a subjective manner – was the evidence provided reasonable enough and consistent enough in order to satisfy the judge. Was the claimant credible?
Furthermore, a recent General Procedure tax court case that came down in March of 2015 was an important win for SR&ED claimants – The Printer Case. The judge specifically rejected CRA’s approach of assessing supporting activities in isolation (a very common CRA tactic)
All of these factors provide claimants with a much better shot of an approval in Tax Court than in Appeals.
You and your company can be approved
It may seem like a hopeless journey. CRA is counting on your despair. By this author’s estimates, fewer than 10% of denied cases end up in tax court. Canadian business owners are easily frustrated with the process, and often prefer to forego the battle. But for those that do file their grievances, and win in court, the benefits far outweigh the sacrifice. After a tax court win, CRA is far less likely to deny your claims in the future. And the claimant can be proud of his or her accomplishments on the win which contributes to the prevailing cases that become part of the precedents upon which future tax court judges will rely.