Wednesday 25 April 2012

Family Trust

There is a lot of discussion now in the media about the proposed tax hike put forward by the Provincial Government of Ontario.  Premier Dalton McGuinty has proposed and dear reader do "note proposed" - it was not mentioned in the budget nor have I seen any proposed legislation - that a new tax bracket will be introduced whereby a two percent tax rate will be applied to annual income of $500,000 or more per year.  Per the Ottawa Citizen this would mean the total tax hike would be 3.12 per cent on income above that level.  This is to start July 1, 2012.

The discussions I have witnessed appear to presume that this will be additional incentive for high net worth individuals to cease residency and to move to a lower cost jurisdiction.  From experience however I will note that moving offshore is often not as easy as it sounds as one must sever ties with Canada and ensure that visitation days in Canada do not amount to 183 days or more within the taxation year as that will re-establish Canadian residency status.  Others have mentioned the setting up of a family trust in Alberta.  Well if this is done then do note that my comments on in the mind and management post  are very much relevant.  If an Alberta trust is created care has to be taken the trust is managed and controlled in Alberta to ensure that the trust remains an Alberta trust and does not become an Ontario Trust.

Tuesday 24 April 2012

Ode to Canada


The other day I happened to notice an immigration consultant’s advertisement encouraging immigration to Canada.  One of the encouragements was that Canada does not have an estate tax.  Yikes I thought.  We may not have an estate tax but we sure do tax on death.  Under the Canadian Income Tax Act, an individual is deemed to have disposed of his or her capital assets at fair market value immediately before death.  This allows the heir to the assets to receive it at fair market value at time of death.  The estate pays the capital taxes due if any.  For the reader who is curious, a capital asset is a long-term asset that is not purchased or sold in the normal course of business such as furniture, land, buildings.  Do note that upon death, one can defer the deemed disposition through a spousal trust. 

I have noticed a fair amount of my readers are from outside of Canada and wanted to clarify that although we  tax capital assets at death here in Canada this does not make Canada less attractive.  I have been fortunate to have worked in Vancouver, Montreal and currently carry out my law practice here in Toronto and can attest to the beauty of this vast country.  The natural beauty of Vancouver where my twins were born will always stay with me – especially at this time of the year when the city’s cherry blossom trees are all abloom.  I adore Montreal – the food, the ambiance, Old Montreal.  Toronto – what I love about this city – is that it truly is a reflection of the United Nations.  Our dentists hail from the Philippines and Cuba.  Our dental hygienist is from Serbia.  Our close friends are Russians, Croatians, many generations ago Canadians and I can continue on. Of course we are all Canadians but it is nice when I can go for Congee in Richmond Hill and feel as if I am in Hong Kong and can carry on a conversation in Dutch.  The twins experienced the celebration of Holi and got covered in colored powder a month ago in Toronto. 

But what I love best about Toronto is the honesty and kindness of its inhabitants. I can attest to that – one of the twins lost her cell phone on the board walk last summer – a flip blackberry – someone found it and called my number which was on the display of the phone.  I managed to lose my Prada wallet with credit cards, all identification and cash – was returned by the Toronto Police – delivered to my door.  I left my gold bracelets in a change room in a shop – returned after I realized I had left it behind four hours later with the sales person telling me “people leave their jewelry behind all the time”.  My daughter left her Marc Jacobs bag behind in a shoe store in the Eaton Centre containing her wallet and yes the same phone which was left behind on the boardwalk – of course we got it back.

Saturday 21 April 2012

Trust or Estate?

The following article was published in the April 2012 edition of Canadian TaxHighlights, a Canadian Tax Foundation publication.  With permission from the Foundation it is reproduced here.  I hope you enjoy reading it as much as I enjoyed writing it.  VoilĂ :

Tax practitioners treat estates as trusts, but trusts are seldom classified as estates. A Canadian trust beneficiary is obliged under subsection 233.6(1) to file form T1142, "Information Return in Respect of Distributions from and Indebtedness to a Non-resident Trust." Form T1142 is due when the Canadian beneficiary's income tax return is due; failure to timely file results in a late-filing penalty of $25 a day, up to a maximum of 100 days (subsection 162(7)). However, "an estate that arose on and as a consequence of the death of an individual" is specifically exempt from the filing obligation, making the distinction between an estate and a trust critical. The recent TCC decision in Hess (2011 TCC 360) dealt with whether a specific trust was an estate and thus exempt from filing.


The CRA historically has interpreted the form T1142 filing exemption as applying only to distributions from estates that were not yet fully administered; it has rejected the view that a US testamentary trust was an estate (CRA document nos. 2007-0233741C6, June 8, 2007, and 2009-033252117, March 23, 2010). Hess is the first judicial consideration of whether the filing exemption applies to a testamentary trust.


In Hess, a testamentary trust was created on the death of the taxpayer's great-uncle. Its beneficiaries were the taxpayer's father and, after his death, the taxpayer. The taxpayer failed to file T1142 forms disclosing distributions received from the trust, and the CRA levied late-filing penalties on the taxpayer for the 2002 to 2006 taxation years for failure to file those forms.


The TCC's analysis turned to the minister's pleadings, which did not challenge the taxpayer's classification of the US trust as a testamentary trust. A testamentary trust is defined in subsection 108(1) as a trust or estate that arose on and as a consequence of an individual's death. Thus, the TCC concluded that the parties' agreement that the trust was a testamentary trust did not preclude it from being part of the great-uncle's estate. The court further said that the minister had failed to address whether the great-uncle's estate had been wound up so that the testamentary trust was a distinct trust administered separate and apart from the estate by, for example, being administered by trustees who were not executors. Because the minister had not addressed the issue of whether the estate had been wound up, he could not argue that the testamentary trust was not an estate. The TCC thus allowed the taxpayer to rely on the form T1142 filing exemption afforded to an estate.


CRA document no. 2011-0407681E5 (November 2, 2011), issued after Hess, appears to concur with the TCC's decision. In response to the question "[w]hether a dual resident of Canada and xxxxx must fill out a T1142 if she is a beneficiary of a foreign trust and received a distribution in the year," the CRA says,

[W]e note that beneficiaries are exempt from filing form T1142 in respect of "an estate that arose on death" when such distributions have arisen before the estate is fully administered (which is normally the year following the death of the individual). However, once the estate has been administered, a Canadian beneficiary of any ongoing non-resident testamentary trust must file form T1142 in any year where a distribution is received from the trust or where the Canadian beneficiary becomes indebted to the trust.
Sunita Doobay
TaxChambers, Toronto

Canadian Tax HighlightsVolume 20, Number 4, April 2012
©2012, Canadian Tax Foundation

Update - April 9, 2017
This article was written in 2012 and since then there has been legislation passed in Canada wherein a Canadian estate is deemed to be a trust. I have not updated the article and hope to so within the next few months.





Thursday 19 April 2012

Please don't allow your investment advisor to forge your signature


Two investment advisors, namely, Mark Steven Rotstein and Jessica Elizabeth Zackheim, were reprimanded yesterday by the Investment Industry Regulatory  Organization of Canada ("IIROC") for forging their client signatures for more than a decade.  In October of 2011, IIROC filed allegations that the pair had forged client signatures for over a decade on documents including trading authorizations, private placement subscription forms, U.S tax certifications, fee schedules and risk disclosure, contrary to IDA ("Investment Dealers Association")  By-law 29.1 and IIROC Dealer Member Rule 29.1.  


According to the Financial Post  the pair, who managed more than 2,000 client accounts at RBC Dominion Securities with assets valued at about $500-million, were terminated for cause by RBC in April of last year (2011), according to a regulatory filing in connection with the case.  They began working at Scotia Capital Inc. the following month, albeit with “terms and conditions” imposed on their regulatory registration, including strict supervision and controls on client signatures. They are still there, a spokesperson for Scotia Capital, the broker-dealer arm of Bank of Nova Scotia, confirmed Tuesday.


Well, I am a loss for words.  After all in this day and age of post Madoff - allowing anyone to forge your signature is just plain foolish.  No financial harm came to the clients of these investment advisors as the signatures were forged not for personal gain or for fraudulent purposes but merely to avoid the clients from the hassle of having to come to the offices of the investment advisors to sign.  But we must remember allowing an investment advisor to forge your signature is not the same as a kid forging their parent's signature on a poor grade assignment.  It is much more serious.  It is human nature to trust easily.  And one only needs to read Vanity Fair's article on Madoff to see how easily one can be duped.


The advisors will be able to serve their one year suspension in two six months stint as long at it completed by October 15, 2014 thereby allowing them to return to work.  Mr. Rotstein will  pay a $250,000 fine to the IIIROC. Ms. Zackheim will pay a fine of $50,000, and the pair will also pay $10,000 in costs.

Monday 16 April 2012

Granny Trusts


The world seems to be shrinking.  When I am now in the Eaton Centre – I find myself trying to guess whether the shopper next to me is from Sao Paulo or from Rio de Janeiro by their accent or from some other part of Brazil. Fourteen years ago hearing Brazilians in the food court would have been a novelty to such an extent that they likely would have been invited home for dinner.  Now I just smile and walk by guessing the origin of the accents.  I of course never stop listening for a Dutch accent from South America.  This quest to speak Dutch however is not so strong anymore with the advance of Skype and believe it or not finding my elementary class mate from de Juliana School.  I found Jozef only a year ago although both Jozef and I have been living in Canada since the early 1980s.  I had heard he had immigrated to Canada but had never been able to find him.  Thanks to Facebook I was able to find Stuart from the home country and through him Jozef. 

I am not rambling dear reader – the whole point I am trying to make is that with so many of us here in Canada with origins elsewhere and with relatives remaining outside of Canada – we should not lose sight of tax planning opportunities.  I already mentioned the immigration trust vehicle which however does not make sense for those of us longer than 5 years in Canada.  

What makes sense and should be considered is the Granny Trust for those of us with relatives back home and where such relatives wish to contribute to the welfare of those in Canada.  Of course an outright gift could be made to the Canadian beneficiaries but as an advisor I caution against direct gifting of large sums.  Direct gifting subjects the funds to claims from creditors, from ex-spouses and can be depleted quickly with poor spending habits of the beneficiaries. 

The Granny trust is named as such because it was set up by one grandparents for the benefit of the grandchildren in Canada.  However it is not restricted to intergenerational gifting.  The name Granny is a misnomer.  It is a foreign trust set up for Canadian beneficiaries by a non-resident settlor and is not limited to grandparents setting up a trust for their grandchildren.  As the trust is known as a Granny Trust, I will continue to refer to it as that.   A Granny trust set up correctly allows the Canadian beneficiary to receive capital from the trust free of Canadian income tax. 

To ensure the Granny trust is not deemed a Canadian trust, the trust has to be managed and controlled outside of Canada.  There can be no Canadian contributors to the trust at any time.  Only a non-resident can contribute to the trust.  The trust can be a testamentary trust which means it is created upon death through the will of the settlor.  The trust can also be set up during the life of the settlor.  A trust set up during the testator’s life time is referred to as an inter-vivos trust.  

The trust must be settled by a non-resident of Canada and must be managed and controlled outside of Canada.  At no time can there be a Canadian contributor.  At all times, the trust contributions must be made by a non-resident of Canada.  Income and gain accumulated in the trust can be added to the capital of the trust which can then paid out free of Canadian income tax to the beneficiary situated in Canada.

Thursday 12 April 2012

Director Liability - Resignation


A topic of interest often overlooked is the resignation of a director.  How does one ensure that a resignation will be recognized by the tax authorities ...





Incorporation protects a proprietor’s personal assets from lawsuits associated with the business such as for example a slip and fall on the premises of the business. Incorporating also protects a proprietor’s personal assets because under corporate law a corporation is a separate legal entity from its shareholder.  A lawsuit action stemming from a corporation’s business will generally not access the shareholder’s assets but will only latch on to the assets of the corporation.  One exception is where the shareholder personally guaranteed a debt of the corporation.  A further exception is where the business was carried out through fraudulent means or was a front for criminal activities.

Another exception where the personal assets of a shareholder are not protected is where the shareholder acts as a director for the corporation and such corporation has failed to remit taxes and/or employee source deductions owing to the Federal and/or Provincial tax authorities.  This is because directors are jointly and severally liable under the tax statutes administered by the provincial and federal tax authorities. Under the law one is a director if one is listed on the minute book and/or is registered with the Provincial or Federal government as a director. Such a director is referred to as a “de jure director”. A director also includes anyone including a shareholder who holds him or herself out to the world as a director.  This is referred to as a “de facto director”.  Note however that anyone can accept the position of a de jure or a de facto director.  Employees or third parties can be nominated to act as directors or they can assume the role of directors by managing the corporation and holding themselves out as directors.

Directors of corporations which run into financial trouble are often advised to resign once the corporation starts having trouble making remittances to the government.  This is because a director who has resigned two years prior to the mailing of a director liability assessment to him or her by the tax authority will not be liable for unpaid taxes and unpaid remittances.  However simply handing in a resignation letter to the corporation or informing Corporate Services is not sufficient.  A resignation for a director must comply with the incorporating legislation of the corporation.  For example the Ontario Business Corporations Act holds that a director cannot resign unless there has been a first shareholders meeting.  Assuming that a director has met the legal requirement of resignation he or she must take care to ensure that he or she is not deemed to be a de facto director by continuing to manage and run the corporate affairs as a director to the world.  

Otherwise a de jure director who has properly resigned will be deemed to have continued as a de facto director without resignation and as such be held personally liable for the corporation’s failure to remit employee source deductions or pay taxes due.

A director whether de facto or de jure should be cognizant of the potential interest and penalties which continue to accumulate when objecting to a director’s liability assessment.  In a 2010 case a director was held liable for interest and penalties of $630,000 which had accumulated while the director disputed the underlying corporation’s assessment of $100,000.  

Incorporation is a good thing.  Most individuals who incorporate do this to avoid subjecting their personal assets to risks associated with the business and to access the more favourable corporate tax regime.  This is good but a shareholder who acts as a director or anyone acting as a director must at all times be cognizant of the director liability provisions contained in the tax statutes.

Mind and management test of De Beers now applies to Trusts



Last night at my daughters’ confirmation I met up with two classmates from Queen’s Law.  They are both godmothers of the twins.  At Queen’s tax law was a mandatory course during first year and that requirement was very upsetting to one of the godmothers to the extent that she was certain she would fail the course and hounded the other godmother and myself with her fears constantly and during our study sessions.  That tax course of which I have fond memories covered both Thibodeau Family Trust v. The Queen 78 DTC 6376 (FCTD) and De Beers Consolidated Mines Ltd. v. Howe, [1906] A.C. 455.  These cases were crucial to the determination of the residency of the Garron trust through three levels of courts (Tax Court of Canada, Federal Court of Appeal and finally the Supreme Court of Canada).

The Supreme Court of Canada released their decision on Garron today.  The proper citation for Garron is FundySettlement v. Canada, 2012 SCC 14.  However Garron is how tax practitioners tend to refer to the case. 

The Supreme Court decision followed the Tax Court and the Federal Court of Appeal which both held that the law of Thibodeau Family Trust v. The Queen 78 DTC 6376 (FCTD) no longer applied but that the residency of a trust was determined by the corporate mind and management test of De Beers Consolidated Mines Ltd. v. Howe, [1906] A.C. 455.

The principle behind Thibodeau which all tax law students from my vintage can recite is that the residence of a trust is determined by the residency of the majority of its trustees.  As such tax practitioners always carefully ensured that the trustees resided offshore when establishing an offshore trust. 

On the other hand if one was trying to determine the residency of a corporation then droned into us was the De Beers test.  De Beers essentially states that a corporation residence is determined by the jurisdiction wherein the corporation’s mind and management resides.  This is then determined by the jurisdiction where the corporate board meets.

In Garron all three level of the Courts disregarded the fact of where the trustees of the trust resided and focused instead on the mind and management behind the trust which was found to be in Canada. In essence the trustees were deemed by the Courts to be puppets rubber stamping documents as directed by the controlling mind in Canada.

Garron’s defence that the corporate residency test as found in De Beers should not be applied to a trust as a trust is not a person like a corporation was dismissed by the Supreme Court.  The Court accepted the Minister of National Revenue’s position that for the purposes of the Income Tax Act, the fact that at common law a trust does not have an independent legal existence was irrelevant and cited subsection 104(2) which deems a trust for purposes of the Income Tax Act to be an individual.

The Supreme Court further held that the similarities between a trust and a corporation warranted the application of the central management and control test application to a trust as both a trust and a corporation:
  • both hold assets that are required to be managed;
  • both involve the acquisition and disposition of assets;
  • both require the management of a business;
  • both require banking and financial arrangements;
  • both may require the instruction of lawyers, accountants and other advisors;
  • both may distribute income, corporations by way of dividends and trusts by distributions.


The Supreme Court concluded with Madame Justice Woods of the tax court that indeed “the function of each is, at a basic level, the management of property”.  The Court further concluded with Madame Justice Woods that adopting a similar test for trusts and corporations promotes “the important principles of consistency, predictability and fairness in the application of tax law” and for there to be a totally different test for trusts than for corporation, there should be good reasons for it.  The Supreme Court noted that no good reasons were offered.

This is an exciting case due to the fact that for years – 34 years to be precise, the Thibodeau doctrine governed the determination of where a trust was resident.  Too think that one could have applied the De Beers test would have been considered blasphemy in my first year tax course at Queen’s. Not to worry about the godmother who feared tax law – she managed to score higher than both myself and the other godmother at the exam.

Tuesday 10 April 2012

Immigrating to Canada ...


The word immigrate brings back memories of middle school where I could never remember the distinction between immigrate and emigrate.  Before I digress – to immigrate means to become a permanent resident in a country other than one’s country of origin. To emigrate means to leave one’s country to settle in another.

When speaking to recent immigrants to Canada, I have noticed that often overlooked in the move is the setting up of an immigration trust.  Yes, dear reader upon immigration you are deemed to have a step up in basis in property you are bringing into Canada but that does not mean that you should not consider an immigration trust.   Non-residents who move to Canada are generally deemed to have disposed of all of their capital assets and deemed to have re-acquired the assets at the value at the time of immigration into Canada (Paragraph 128.1(1)(b) of the Income Tax Act).  I digress.

An immigration trust allows a new immigrant to Canada to defer Canadian taxation on income and capital gains earned by the trust for 60 months.  As Canadian residents are taxed on income earned worldwide, a tax holiday for 60 months is a good thing.  The 60 month time clock starts clicking on the date residency is assumed in Canada.  For an immigrant who did not think of utilizing an immigration trust prior to landing in Canada, a trust can still be set up after landing.  The 60 months is merely reduced by the number of months resident in Canada.  And of course there may be Canadian capital gains or income tax on the increase in value from the time residency was assumed to the time of transfer of the asset into trust.
An immigration trust has to be a non-resident trust.   Under Canadian law this means that the mind and management, control, of the trust must be exercised outside of Canada.  It is imperative that the immigrant to Canada not exercise control over the trust.  I would recommend that a trust company situated in the jurisdiction where the trust is located manage the trust. 

The trust need not be funded with cash but can be funded with real estate as well.  Do check with the various trust companies on what they will accept as assets as this will enable the Canadian resident to accumulate free from Canadian tax gains on the disposition of these assets.  At the end of the 60 months there are several strategies to employ, one of which is to wind up the trust by moving it to Canada and distributing the capital assets to the beneficiaries free of Canadian tax.  The beneficiaries of the trust will receive the assets of the trust at the fair market value established at the date of the winding up of the trust.
 
The above is merely an overview and thoughts on immigration to Canada.  Further planning can of course be done but I wanted to highlight to the reader that when moving to Canada it is wise to consider the immigration trust.  Parliament was generous to allow this legislation as it gives the immigrant to Canada peace of mind that in the event Canada was not to be his or her final destination emigration from Canada would at least be painless from a tax perspective.

Monday 9 April 2012

$100,000 or more in assets outside of Canada?


Information returns such as
·         Form T1134-A and Form T1134-B information regarding foreign affiliates and controlled foreign affiliates
·         Form T1135 - information regarding foreign property
·         Form T1141- information regarding transfers to non-resident trusts
·         Form T1142- information regarding distributions from and indebtedness to a non-resident trust
 are due when a Canadian resident’s income tax return is due.  Generally individual returns are due on the 30th of April.  Individuals who are self-employed file their income tax returns on the 15th of June but are obligated just as the April 30th filers to remit any income taxes owing by the 30th of April.  The focus of this commentary is solely on Form T1135.

Form T1135, Foreign Income Verification Statement, has to be filed if you hold minimum $100,000 in a bank account outside of Canada or hold rental property valued at $100,000 or more outside of Canada.  The following property if held outside of Canada and valued  at $100,000 or more must also be reported on Form T1135 :
  •         Government or corporate bonds;
  •     Shares of a Canadian Corporation;
  •          Patents, copyrights or trademarks;
  •          Precious metals, gold certificates and futures.

The above list is not the complete list but merely an illustration of what has to be reported.

Form  T1135  does not have to be filed if the property held outside of Canada is held for personal usage such as vacation property used primarily as a personal residence by you or personal property such as work of art, jewelry, rare books, stamps and coins. 

Failure to file an information return such as Form  T1135  and of course assuming that you have to file such an information return, will subject you to a penalty of $25 a day up to a maximum of 100 days.  Do note that CRA will levy interest on the penalty of $2,500 if not paid on a timely basis. 

In  Jean-Claude LeClerc, 2010 TCC 99, the taxpayer Mr. LeClerc  owned a condominium in Poiters, France.  The value of the condo exceeded $100,000.  The facts do not state this but I assume the condo was rental property.  Mr. LeClerc  filed his tax returns for 2003 and 2006 late. His 2003 return was filed on September 18, 2007 and his 2006 return on June 19, 2008. 
Prior to 2003 he had filed his Form T1135 with his tax return on a timely basis.  However due to a family illness he was late with his 2003 and his 2006 return.  CRA imposed a penalty on the taxpayer for the late filing of Form T1135 which in the case for the taxation year amounted to $3,395.71.   The $3,395.71 figure includes the maximum $2,500 penalty plus interest.  Mr. LeClerc argued in vain that this did not make sense as the penalty levied was for an information return for a property of which CRA already  was aware of its existence due to prior timely filed returns.     

Justice Favreau presiding over the case at the Tax Court noted that pursuant to CRA’s policy the only means to a relief from the penalty was to apply under the Voluntary Disclosure Program.  There was no other recourse as the wordings of the applicable sections of the Act, namely subsection 162(7) and 233.3(3) were clear and posed no difficulty of interpretation of Parliament’s intention which was to motivate taxpayers owning foreign property with a value exceeding $100,000 to report such property.  Justice Favreau’s hands were tied and he acknowledged that the Voluntary Disclosure Program should not be the solution for a taxpayer to seek relief from penalties assessed for the late filing of Form T1135.  In Paragraph 19 he states “the appellant cannot be blamed for his lack of knowledge with regard to that program even though he had studied tax law.  In fact, it is not obvious that that program could apply to taxpayers who did not commit fraud and who reported all their foreign-source income for several years”.  Justice Favreau concluded that the matter should be left for Parliament to decide.

Dear reader, if you have neglected to file Form  T1135  or other information returns on a timely basis in previous years, then you may wish to consider the Voluntary Disclosure Program to seek relief from CRA’s penalty and interest that will likely be levied against you.
The guidelines as set out by CRA states that one can only file under the Voluntary Disclosure Program if
  •          the disclosure is voluntary i.e. there is no pending enforcement action;
  •          it is complete; the period of non-compliance is at least one year past due; and
  •          the applicant is subject to penalties for the compliance at issue.






Tuesday 3 April 2012

Technical Uncertainty - SR&ED

The scientific research and experimental development ("SR&ED") tax incentive program is a generous program provided by the Federal Government of Canada.  It provides annually about $4 billion in investment tax credits to over 18,000 claimants.  This said - a claimant can not simply claim that the research and development carried out qualifies as SR&ED.  For research and development to qualify as SR&ED one of the hurdles that must be overcome is that of proving that the R&D was not simply routine engineering.  It is necessary to show that the focus of the R&D was to overcome a technical uncertainty.  The following was first published in the Canadian Tax Highlights, a Canadian Tax Foundation publication.


SR & ED Technical Uncertainty

Recent 2011 SR&ED cases - Soneil International (2011 TCC 391) and Jentel Manufacturing (2011 FCA 355) - illustrate the futility of claiming expenditures as SRED if it cannot be established that the research and development centered around overcoming a technical uncertainty that could not be resolved through routine engineering. In Jentel the goal of the R&D was to obtain a smaller and lighter version of its existing multi-bin product and in Soneil the goal was to improve existing switch battery technology.


SR&ED is defined in subsection 248(1) and paragraph (c) was relevant in each case. SR&ED is

... systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is...
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.

When making a SR&ED claim the onus is on the taxpayer to show, on the balance of probabilities, that the expenditures it incurred were for SR&ED as defined (Zeuter Developments 2006 TCC 597.)


Paragraph (c) of the definition was also relevant in Northwest Hydraulic Consultants (3 CTC 2520), in which the TCC set out an invaluable list of five steps to determine when R&D can be considered to be SR&ED.  The first step is whether there is a technical risk or uncertainty, a step that the taxpayers in both Soneil and Jentel failed to meet. Justice Bowman elaborated on the meaning of “technical risk or uncertainty”:


 Implicit in the term "technical risk or uncertainty" in this context is the requirement that it be a type of uncertainty that cannot be removed by routine engineering or standard procedures. I am not talking about the fact that whenever a problem is identified there may be some doubt concerning the way in which it will be solved. If the resolution of the problem is reasonably predictable using standard procedure or routine engineering there is no technological uncertainty as used in this context.


In other words the taxpayer cannot simply state that a procedure is technically uncertain; the taxpayer must demonstrate that the technological uncertainty could not be solved by routine engineering.


In Soneil the taxpayer listed four technical uncertainties that needed to be overcome but failed to demonstrate why they could not be overcome by routine engineering. The TCC confirmed that the list of the four uncertainties “was the only evidence provided by the [taxpayer]…. It is simply not clear to me whether he is referring to uncertainties that could be resolved by scientific research and experimental development or if he is referring to redesign issues that could have been resolved by using techniques, procedures, and data that were generally available to competent professionals in the field”. The TCC also noted that the taxpayers not only failed to provide sufficient evidence that a technological risk or uncertainty existed, but also failed to provide sufficient evidence that testing was performed to overcome the technical uncertainties. The court quoted from its earlier decision in Zeuter Developments:


… While not absolutely necessary, it is beyond doubt that a taxpayer who creates a well-supported claim will facilitate the process in determining whether something qualifies as SR&ED. As stated in RIS-Christie, the only reliable method of demonstrating that scientific research was undertaken in a systematic fashion is to produce documentary evidence.

The taxpayer thus failed to show on a balance of probabilities that its R&D qualified as SR&ED because it failed to show that the technical uncertainties for which it was conducting R&D could not be overcome through routine engineering. 


In Jentel the taxpayer developed and manufactured thermoformed plastic products that were engineered for consumer and industrial uses.  Before its 2005 fiscal year, Jentel had developed a storage unit: Multi-Bins, a small storage system typically used in industrial and shop-floor settings. During its 2005 fiscal year the company sought to overhaul and improve the Multi-Bins concept by redesigning a smaller and significantly lighter version. The taxpayer characterized the R&D issue as technical uncertainty that arose because the properties of plastic become unknown when it was extruded. The testimony given in court and deduced from the TCC decision appears to have been centered on the testing procedures that the taxpayer undertook to achieve the final product goal. 


Similar to Soneil, the taxpayer in Jentel  failed to establish the technical uncertainties that needed to be overcome through R&D.  Jentel’s expert witness focused on the testing that was done to obtain the final result and the only technical uncertainty he mentioned was the unknown property changes of a plastic resin when extruded. However, the court concluded that the extruding of plastics was not a technical uncertainty that could not be overcome by routine engineering.

The FCA agreed. The FCA said that the activities carried out by Jentel in its fiscal 2005 year were of a routine nature. The fact that Jentel had previously used both injection moulding and thermoforming and did not just begin to use those methods in 2005 supports the reasonableness of the conclusion that the taxpayer was using an available standard manufacturing process.

Sunita Doobay
TaxChambers, Toronto
©2012, Canadian Tax Foundation



Canadian Tax Highlights
Volume 20, Number 3, March 2012