Tuesday, 7 August 2012

Contemporaneous SR & ED Documentation

Recently published in the Canadian Tax Highlights and reposted here with permission is the following article on the documentation requirement when claiming SR&ED:

The recent decision of the TCC in Murray Arlin Dentistry Professional Corporation v. The Queen (2012 TCC 133) was heard under the informal procedure and thus has no precedential value. Nonetheless, the decision is a reminder of the need to maintain contemporaneous documentation to evidence the fact that research was performed by the SR & ED claimant.

The taxpayer was a professional corporation operating the dental practice of Dr. A, a periodontist who specialized in implants. Dr. A spent at least one day a week studying data produced by specialized software that tracked the success rates of implants and the variables that affected those rates. Woods J accepted that the doctor’s research was a useful addition to scientific knowledge; at issue was whether for the 2007 and 2008 taxation years the doctor could prove that he spent an average of 350 hours per year systematically carrying out that research.

Woods J noted that SR & ED is defined in subsection 248(1) to mean a “systematic investigation or search that is carried out in a field of science or technology.” The TCC’s decision in Northwest Hydraulic Consultants Ltd. (1998 CanLII 553) remains the leading case on the meaning of “systematic investigation.” In that decision, Bowman J said that “[a]lthough the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests and results be kept, and that it be kept as the work progresses.”

The facts in Murray Arlin show that Dr. A carried out research and that he did so on at least one day each week; but he never documented the hours spent, nor did he provide a hypothesis on what “uncertainty” he was overcoming with the data that he collected. Dr. A was a prolific writer, lecturer, and participant in study clubs. He used about 50 of the possible 200 software variables—such as whether the patient smoked and the type of implant—to track success rates. He had records for about 12,000 implants performed by him (approximately 1,000 surgeries a year). The CRA submitted that Dr. A “failed to develop specific hypotheses prior to the data collection” and that there was insufficient evidence of the time spent by him studying the data. Northwest Hydraulic analyzed the need for technical risk or uncertainty and the need for the claimant to “formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty.” Although Dr. A testified briefly that he updated his research for his lectures, many of the lectures were not given to implant specialists and they had a marketing component. The evidence was far too vague to establish the time spent on analysis or data collection and thus the one-fifth allocation of salary: the software was “designed to present comparative tables at the press of a button. The actual time spent on applied research potentially might be very small.”  Woods J agreed with the minister that without a hypothesis there could be no systematic investigation, but she was reluctant to agree that such a narrow position precluded a finding that there was insufficient evidence of systematic investigation. 

The major obstacle to ruling in the taxpayer’s favour was the lack of documentation: “The main problem that I have with the appellant’s position is that there was very little detailed evidence regarding the analysis done in the years at issue and the time spent.”

Sunita Doobay
TaxChambers, Toronto

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