Part 1 of this article talked about some of the extra nuances and baggage that the Canada Revenue Agency (CRA) has recently begun adding to terminology that we use in the assessment and preparation of SR&ED claims, along with some of the implications (reduced claims). In this part, I’m going to examine one of the CRA’s favourite policy documents to highlight and discuss some of the current differences.
The Information Circular IC86-4R3 Scientific Research and Experimental Development was published May 24, 1994 (approximately 17 years ago), and has served as CRA’s main reference document for SR&ED ever since, even among the proliferation of additional policy and application documents, and sometimes, it appeared, preferred over referencing the income tax act itself.
Bear with me as I’m going to quote a couple of sections from IC 86-4R3. The definition of scientific or technological uncertainty as described in Section 2.10.2 (bolding/underlining is mine):
2.10.2 The criterion of scientific or technological uncertainty is as follows:
• 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 scientific or 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 or scientific uncertainty through a program of scientific research or experimental development. Specifically, scientific or technological uncertainty may occur in either of two ways:
- it may be uncertain whether the goals can be achieved at all; or
- the taxpayer 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 scientific or technological uncertainty, rather than the economic or financial risk, is important in characterizing scientific research and experimental development -- and, hence, eligible activities.
• Sometimes there is little doubt that a product or process can be produced 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.
• This criterion applies equally to work on new or existing processes or products. The description of technological uncertainty contained in this subsection applies wherever the text of this circular refers to the criterion.
And later in the same document:
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 in the complexity of the technology 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 and environment 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.
These sections contain a number of wordings or approaches that are quite foreign to the CRA’s current message.
Variance 1 – Uncertainty as Doubt. The notions of uncertainty expressed as to overall approach (Uncertainty Whether), or a doubt about potential success, or as to which of several approaches is best used, as in, “we didn’t know if this approach would work.” (Call this one: Uncertainty Which.) This allows considerably more latitude than the current definition (Uncertainty How) which expects the problem to be already clearly understood and the technology gap or barrier to be already precisely defined, thus leaving a lot of early exploratory work off the table.
Variance 2 – Uncertainty re Approach. Uncertainty whether a thing can be achieved, or uncertainty about which is the best of several alternatives, are both materially more inclusive, from an eligibility perspective, than uncertainty about how to overcome a more narrowly defined and specified problem. Of these two variants (uncertainty whether, uncertainty which), it is the uncertainty whether, which I have also described as “uncertainty as doubt”, that is more inclusive and allows greater scope for eligible activity. However, the uncertainty about which approach is best applies even in situations where CRA is insisting on it’s current, narrower definition – once the problem is totally and clearly defined and understood, there would still be a need to consider multiple experimental approaches. Otherwise, there would be no experimental development. But this uncertainty, when linked with the first, enables the claimant to include a whole range of explorative and analytical activity previously used to help in understanding and clarifying the nature of the technology barrier or gap. This is work which, even if experimental in its nature, the CRA would currently seek to exclude, because the technology barrier or gap had not yet been narrowed to a single, clearly focused problem.
Bruce Madole
What technical means… to CRA
What the CRA is teaching now is that the word “technical” refers generically to a domain of activity – technical content, technical issues, technical questions, and technical uncertainty – many of which are perhaps purely routine in nature. (Though, perhaps not, although CRA now tries to taint the word “technical” with an implied additional meaning of “probably routine”.)
What technical uncertainty means… to CRA
Technical uncertainty, as they now characterize it, means “not knowing what to do next,” or “how best to approach” an un-clarified problem or a technology issue that is not yet fully understood. The phrase implies a need for more detailed investigation to more fully penetrate to the specific technology gap or barrier that represents what CRA calls the “technological uncertainty.” So to CRA, technical uncertainty means ambiguity, unrefined or unfocussed enquiry, doubt, ignorance, confusion, lack of clarity. It implies ineligible work or due diligence activities, carried out in hope of finding some root cause or problem that can then be tackled as a SR&ED project. Technical uncertainty, to the CRA, means that you don’t yet know what you’re doing.
To CRA (I paraphrase here), you have not penetrated to the real SR&ED project until you have “moved beyond the technical uncertainty and have uncovered and fully understood all the dimensions of the “underlying technology gap”. In CRA’s opinion, you have to move beyond the pursuit of “know what” to the pursuit of “know-how”, as in, “How do we experimentally approach the solution to this very specific technology gap or barrier?”
Until the problem is fully understood, they would argue that your efforts are reconnaissance, and due diligence (using standard approaches, probably), and not experimental development.
Despite the Canada Revenue Agency’s current position, there is a long history of claiming SR&ED projects on the basis of “technical uncertainty”, and the scope of such projects was larger because the starting point for the SR&ED was significantly less restrictive.
The tax authorities themselves have historically used “technical” and “technological” more or less interchangeably when talking about the more vital part of that phrase: uncertainty. Part 2 of this article will examine that aspect in more detail, along with some other troubling implications of this new approach.
Bruce Madole
If you have come to the world of SR&ED expecting that the CRA will treat you and your claims in a manner consistent with their published information, you will be sadly disappointed, and probably frustrated. It’s no wonder companies look to the assistance of consulting firms for help. It certainly doesn’t help matters when the definitions applied to words are being shifted, and loaded up with some unwelcome and extra freight in the form of additional meanings and implications that most of us just wouldn’t use.
I attended a CRA public information session recently, just to see what the current training session includes, and I noticed them applying a particular set of definitions and interpretations that could really spoil your day.
When we speak of technology, we usually refer to the set of tools, equipment, systems, networks, machinery, and so on, with which the business creates or delivers the goods, products or services on which the business is based. (Note that we are not speaking here about the goods, products or services themselves, but the technology set that underlies or enables them.)
To most people, talking about “technical uncertainty” would appear to mean the same thing as “technological uncertainty”. To the CRA, currently, these phrases carry materially different meanings. (I’m not sure if the rest of the world embraces these definitions and assumptions.) However, we need to equip ourselves for the discussion. Are the different definitions, discussed below, purely a clarification of old intentions? Do they represent a mostly academic debate about historically equivalent expressions? Or is this some kind of a semantic shell game designed to slash the definitions of eligible work, and organized around a nuance of language that CRA is alone in perpetuating?
To be continued...
Bruce Madole
Just about any book or guide on Canada’s Scientific Research & Experimental Development (SR&ED) Program will include references to SR&ED-related court cases, if not an entire section. Does anybody read them? Really?
Of course we do. Probably, most SR&ED practitioners spend some time studying court cases. (I make a personal hobby of it, including the analysis and classifications of the assorted causes for ending up before the courts, but that’s just me.) It might even be inescapable that we do so: legal precedents and judgments augment the law or change the law, or however you might choose to phrase it -- I’m not a lawyer – in ways that have more force and lasting influence than any CRA guidance document or bulletin. SR&ED court cases change the world we work in, and the rules that we work by. So, a careful consultant pays attention to such things.
The big question is: does anybody else really notice or care? Should they?
How do we actually use the information gained in studying cases? Does it change the advice we give our clients? Does it change the CRA’s behavior or official interpretations? Has it changed their practical approach to the review of claims or their treatment of claimants?
To be continued...
Bruce Madole
It really drives me crazy when companies make decisions that accidentally limit their potential for SR&ED – or eliminate the possibility of claiming SR&ED altogether. Any in-house SR&ED program exists to serve the needs of the business, not the other way round. Any external consultancy exists, likewise, to serve the best interests of the client. If a company has decided to do something that is detrimental to the potential for SR&ED, so be it – but if the decision is not an informed decision, then I feel as though I have failed in some way.
SR&ED is a complex program, reaching across many parts of an organization, and likewise, influenced by decisions taken in many different areas. Companies may too easily make decisions on matters without understanding SR&ED impact. Occasionally, those impacts may be considerable, with the potential to undermine or offset the benefits implied in a business case.
Example one: contract terms
Consider, for example, a decision about the technical development of a new, technically risky proposed system. Unsure about whether the sought capabilities could be developed in house, and assuming that commercial off-the-shelf (COTS) solutions could not address the problem, a company might well decide to limit its risk in proceeding with development by agreeing to a firm fixed price contract with a supplier. It’s a proven approach to managing project risk.
That such a contract would prevent filing a SR&ED claim for the costs of the work may not be material to the decision about risk – but the potential tax credits recoverable might equally well have been understood as a mitigation of risks, and weighed in the balance.
A fixed-price contract “ceiling” would reduce the impact and risks of the over-run, just as penalty clauses might offset the risks of delays, but the possibility of a total failure would exist regardless. The impact of such a failure would have to be mitigated by other means: what does the business do, if the vendor can’t deliver, assuming they still need those capabilities? Start over? Lawsuits? Both?
Filing a SR&ED claim might have been useful as a way to mitigate some of the costs of the failure, if the firm fixed price contract terms had not been used. Investment tax credits recoverable might have proven a useful source of supplemental funding for the essential innovation. Thus, the choice of a contract and procurement approach has become a limiting factor in a project without anyone ever consciously making a decision about SR&ED.
Tough luck, that.
To be continued.
Bruce Madole
Superman is In: This person will claim even the most complex, challenging problems are routine. Ho Hum. Leaping tall buildings, speeding locomotives, technology innovation – all routine. Which would explain why their project budget has doubled, deadlines have slipped, and a project SWAT team has been formed to seek alternatives to the original design. This is all just “standard stuff.” Really.
Captain Nemo - The Submariner: This person will wait until the middle of the science review before they fire off some damaging torpedo of a statement, perhaps even totally changing their story, and thus crippling or sinking an entire claim. This is a pre-emptive strike of the highest order: in exchange for the effort of moving forward with and then sinking one single claim, they may earn your permanent distrust and reluctance to work with such a “loose cannon” ever again, thus relieving them of the need to ever again participate in the same program.
In some scenarios, it is impossible to deny the implied or explicit criticisms as we tell ourselves that a more detailed and scrupulous verification of the initial facts would have revealed the flaws in a supporting story. Some people just remember things incorrectly, or with a highly personal spin on reality. A certain amount of cross-checking and verification is expected, as a part of our due diligence, but neither can one afford to treat key stakeholders as though they were pathologically incapable of providing facts or telling the truth about what happened in their projects.
Therefore, although I expect somebody to “game the system” consciously or unconsciously, I’m not necessarily going to confront this behaviour head on. Not right away. Misunderstandings are possible, mistakes may be made, and individual “witnesses” may remember things differently, without the presence of any active malice or subterfuge.
On the other hand, once a pattern of resistance or sabotage emerges, you need to intervene, to educate, or even to escalate. You’ll know when.
Bruce Madole
If you have a SR&ED process in place, sooner or later, somebody is going to tell you that a project is not eligible… purely because they don’t want to be burdened with supporting a claim. Hard as it may seem to believe… people will sometimes resist participating in the SR&ED program.
Commonly, these are people whose workload is already towering near the maximum, or well beyond it, in the metaphorical in-tray. In the back of their minds, a little voice recognizes the SR&ED assessment task as a source of potential additional work, and it chimes in with “ ohmigawd… really? I don’t think so…” even as the conscious mind latches on to a convenient rationale for dismissing the whole idea. You know… before this SR&ED silliness gets out of hand.
Any kind of a program involving compliance represents an additional burden of work at some point. Somehow the compliance work is almost always in addition to the regular workload, and there’s always somebody for whom this demand represents a threat, the final, wholly-inconvenient straw. Their thinking is natural: “If I don’t say that it’s eligible, I won’t have to work on it. Or commit staff and resources to it.”
This kind of gaming the system essentially deprives their employer of what could be an important benefit or source of funding – perhaps even the funding that might justify an extra headcount under tight budget conditions. Still, there are different ways in which the process might be sabotaged, and lots of individual reasons for doing so. Here are a few common types of “SR&ED Resisters”.
The Myth-Maker, aka The Wizard of Flaws: This person would have you believe that “all SR&ED is a scam or a fraud, perpetuated against taxpayers, with the connivance of weak-willed politicians… and so of course, we don’t do any of that here. Pay no attention to that man behind the curtain.”
The Near-Myth: This person will admit the possibility that SR&ED exists, but like the previous type, insists that it never happens “around here, on my project” or “not on this occasion” (or any other occasion you might choose to think of), though they may admit that a given project “comes close” to meeting the definitions. To this person, SR&ED work is just a theoretical possibility, you understand, in the current environment, and will only become a reality at some time after you have detected large flocks of flying swine.
To be continued...
Bruce Madole
Once a SR&ED team reaches a level of meaningful financial return, it becomes a pawn for the political games.
Be warned, however. There is one vital stakeholder that is almost always overlooked in these games-playing scenarios, because that stakeholder is external to every claimant: the Canada Revenue Agency (CRA), which is responsible for assessing every claim made. The CRA is very clear in its preferences – they want to see a claimant’s SR&ED function located within the technology area for any claimant. This is because the “science” aspects of the claim are required to drive every other aspect of it, and the determination of eligible activity needs to be led by the people who do the technical work, and who understand the nature of the technological uncertainties.
Any organization that does not locate SR&ED within its technical domains will be subject to higher levels of mistrust and scrutiny from CRA Science Reviewers, based on the CRA’s fundamental suspicion that financial or taxation teams leading a SR&ED effort will inevitably over-claim because they lack the foundational technical knowledge to discriminate between the eligible and ineligible.
It should be understood, therefore, that any move to reposition SR&ED outside the technical domains of a company is inherently risky, and potentially damaging to the perception and effectiveness of the program itself.
Will this knowledge alter the behaviour of the corporate games players? Probably not. But it may be food for thought.
So… let the games begin.
Bruce Madole
There’s nothing quite like the scent of money to bring out the corporate games players and political opportunists, but if a company isn’t careful, these games players can foul up a perfectly sound SR&ED program. Unfortunately, the very nature of the SR&ED program makes this scenario more possible.
One phenomenon that seems to be unique to large organizations is the person I like to call a “SR&ED Vulture”. (You could just as easily call them SR&ED Sharks, for that matter.) These are usually a highly-placed or highly-connected manager (Director, VP, …you name it) – who sees the evidence of real promise in the corporate SR&ED program, and proceeds to make a play for control of the program.
There’s nothing like controlling the cash cow to impart a little clout.
Now, making their play may be as overt as “muscling in” or playing “reorganization or re-alignment games”, and it can be surprisingly easy to accomplish. After all, these are people with friends and contacts in high places, so you can expect them to possess influence, already. Moreover, there are factors about any SR&ED program that make it more vulnerable to games playing.
SR&ED is a hybrid program in any large organization, requiring a complex cooperation and integration between the taxation team (that files the actual tax claims), the Finance and Accounting teams (which control all of the accounting and reporting functions), and the technology, systems, engineering and product development areas, for example, where all of the eligible technical work, and the assessment functions, properly reside. And then there’s the Human Resources area, which typically serves as a “gatekeeper” to preserve control of anything the HR folks see as belonging in their domain, such information about employee salaries, qualifications, privacy, etc. Locate the SR&ED program in any one of these domains, and a smart political operator can make some kind of a case for locating it elsewhere, under his or her own control. SR&ED is too frequently seen as an “orphan” within any of these specific domains (particularly in the immature stages) lacking a proper parent to say “this child is mine” – i.e., that there are good and sufficient strategic reasons to be involved in raising and nurturing it – which makes the SR&ED program surprisingly easy to uproot and relocate.
All too often, those responsible for SR&ED don’t really know what to do with it, and feel uncomfortable about the alignment between a SR&ED team and their core mission.
That is, until the real money starts to flow.
To be continued...
Bruce Madole
Their learning goals were much more narrowly focused, and while nobody actually cried (that I saw), I suspect that I was boring many of them nearly to tears. Mostly, when this happens, people tune out more than the most boring bits – they start to totally lose their grip on the wet soap of learning. Minds drift, and the relevant bits that follow after are lost in the fog of “what am I doing here, really?” and “When will he shut the hell up?”
Net result, if you had asked someone what the session was about, they might have said, “It was something to do with SR&ED tax credits”. Hardly the kind of learning designed to transform and energize an organization in support of a SR&ED program.
Though I was passionate and persistent, over time I learned that SR&ED awareness training needs to be delivered frequently, in many different ways and in specifically focused, small packages of task-specific learning.
Mostly, people want to learn what it is I need them to do. To do… not to know. Therefore, while I do not neglect the “why” in the training sessions I deliver, I try to place a lot more emphasis on the what, the how, and the when of the SR&ED tasks that directly affect their working lives. These are busy, busy people. Vendor Managers have contracts and relationships to manage. Lawyers are lawyers, after all, and financial types have all of those numbers to deal with. Project Managers have projects to run, and engineers, well… you know: everybody has their own, very real, very demanding work to do. They might be willing to help support me in what I’m doing, but they’re definitely not signing up to do what I do.
This has meant, in effect, that the “Everything You Might Ever Want Know About SR&ED” approach was reduced to the “Only What You Need to Know About SR&ED Right Now” approach.
That helps. A lot.
Bruce Madole