Changes to SR&ED claim form

CRA is to publish a new Form T661, the SR&ED claim form, in October. Along with the changes in rates for 2014, there will also be changes to Part 2, the section for technical description of the work being claimed.

This is necessary because while the Eligibility paper, and the other new guidance documents, discuss scientific uncertainty as a necessary element of eligible scientific research, there is no mention of scientific uncertainty on the current form, and no way for claimants to include that information in their submission.

The announcement does refer to three questions (not five), but mentions they will be re-ordered for more consistency with the Eligibility paper.

The announcement is at http://www.cra-arc.gc.ca/txcrdt/sred-rsde/whtsnw/msg-t661-2013rvsn-eng.html  

Naturally occurring documentation

CRA’s instructions on documentation have not changed; the new guidance material still advises that “records generated during the normal course of a project should be sufficient to support a claim for SR&ED”. This does not mean (if it ever did) that program users can assume their regular paperwork, whatever it happens to be, will meet CRA’s evidence requirements. While there may be organisations whose regular record-keeping does reach that standard, for most companies some extra effort is needed. 

A more useful interpretation takes into account the new 5-step approach for evaluating projects as SR&ED. Since generating appropriate records is now regarded as a defining characteristic of a SR&ED project, a project with insufficient supporting evidence is not just unsubstantiated, it is ineligible. With that in mind, CRA’s advice is actually saying that if a project doesn’t, as part of its normal operation, generate the type of documentation required to support a SR&ED claim, then it can’t be a SR&ED project. This includes contemporaneous reports of objectives, uncertainties, hypotheses etc., as necessary to demonstrate that the scientific method was followed.  

Program users need to take a fresh look at the records currently being produced, and evaluate them in the light of current SR&ED requirements. This effort is worthwhile, because claims with inadequate records are likely to be disallowed. Operating procedures then need to be adjusted so that generation of documentation to meet the requirements becomes part of the regular development process. These additional records should be designed to enhance the development process in a way that provides the additional information, rather than address SR&ED issues directly - CRA have made it clear they do not wish to see documentation that was produced as claim support rather than as part of the SR&ED process.

Time Matters

One of the shifts occuring in the SR&ED program is to do with timing. Not so long ago, serious consideration of a development project as SR&ED was often left until the work was well under way or complete - until, that is, the nature and extent of the challenges and technological progress had become clear. At filing time the project description would cover advancements made or attempted, obstacles encountered, and a factual account of the work done. The technical reviewer would investigate other aspects of the claim through site visits and meetings with the people who did the work. While claimants were encouraged to keep records of who did what when, and the related costs, it was not expected that such things as theories about what might work would be written down at the beginning of the project.  

Times have changed. Over the last few years CRA’s requirements have been evolving, and now that the new policy papers are in effect they are quite clear; a primary characteristic of the SR&ED project as currently explained is that it follows an experimental process referred to as the “scientific method”. This involves the early identification of one or more uncertainties, formulation of hypotheses to reduce or eliminate them, and subsequent testing and modification of the hypotheses, with supporting evidence from records created at the time. In practical terms this means that the point at which attention is first focused on these aspects of the work needs to move forward in time by at least 18 months, and possibly several years - from when the project is written up for a claim, or explained to a CRA technical reviewer, to the time the project begins - so that appropriate records are available to support the claim. 

While individual reviewers may still take a more flexible approach, program users ignoring this requirement risk losing credit for otherwise eligible work.

There are CRA services that support early attention to these issues; PCPR (Pre Claim Project Review), Process Review, and especially the proposed formal pre-approval service that is about to be piloted (FPAP).

New policy guidelines

CRA’s “Policy Review Project” for SR&ED has reached its final phase. Twenty new policy documents have been posted on the CRA website, to cover all aspects of the program. The papers are mostly financial or financial/technical, with a single paper on eligibility. While in draft, each paper was posted briefly for public comment - on style, not on policy interpretation. 

While the familiar guidance material, such as Application Paper 86-4R3,  is to remain on the CRA website until June 2013, the new documents take effect immediately.  Aside from the paper on eligibility, which is brief and high-level, the only other guidance on technical matters available to program users is now Part 2 of the Guide to Form T661, the Guide for Claimants, and the redacted version of the reviewers’ Claim Review Manual.

As there has been no change in the definition of SR&ED in the legislation, any perceived policy differences in the new documents are to be regarded as clarifications rather than changes. This means no delay in implementation is required, and the new guidelines may be applied to existing claims that were prepared in accordance with the old guidelines, and to claims already under review.

Although CRA guidelines do not have the force of law, they are binding on CRA reviewers, and so for practical purposes these are the policy interpretations now in effect. They are as yet untested by the courts, and in the past the courts have endorsed CRA directives only to the extent that they were developed through consultations with program stakeholders; it will be interesting to see whether there are any legal challenges.

SR&ED cutbacks are based on incomplete data.

New budget measures significantly reduce the value of the SR&ED tax credit. The rationale is that Canada’s business investment in R&D is low compared to other countries and has been falling steadily for the last few years, so the private sector must have failed to take proper advantage of the support being offered and the resources would be better used elsewhere. What this does not taken into account is that other factors have influenced the data on private-sector R&D investment, and comparisons and analyses based on that data are therefore unreliable. 

Information on business expenditures on R&D by smaller R&D performers comes directly from the SR&ED database, and for larger companies is collected in response to surveys by Statistics Canada. Until very recently, the survey website has carried a definition of R&D similar to the definition of SR&ED in the Income Tax Act. Unfortunately the SR&ED definition is based on the 50-year old model of R&D in the original edition of the Frascati Manual, the OECD’s manual on research classification. It is considerably narrower than the definition in the current edition of the Manual, which is the one in use in most other countries. In consequence, much work that would be counted as R&D elsewhere has not been included in the Canadian statistics, skewing the international rankings for R&D expenditure. Another factor is the tightening of the documentation requirements for SR&ED claims over the last few years; if only work accepted as SR&ED has been included in the numbers reported to Statistics Canada, this could appear to be a drop in the level of R&D being performed. 

For the new round of data collection, which began in October 2012, Statistics Canada has replaced the definition on their website with one much closer to the current OECD description - less academic and more business-oriented. The restriction to work in the natural sciences and engineering has been dropped, so R&D in the knowledge economy may begin to be included as part of Canada’s R&D effort. If Canadian R&D performers base their reports on these new standards, the data available to Statistics Canada may begin to more accurately represent the level of private-sector R&D.

New Statistics Canada definition of R&D:

“Research and development project” refers to creative work undertaken on a systematic basis in order to increase the stock of scientific and technical knowledge and to use this knowledge in new applications. The central characteristic of a research and development project (R&D) is an appreciable element of novelty and uncertainty. New knowledge, products or processes are sought. New knowledge involves the integration of newly acquired information into existing hypotheses, the formulation and testing of new hypotheses or the re-evaluation of existing hypotheses, the formulation and testing of new hypotheses or the re-evaluation of existing observations. An R&D project generally has three characteristics:

• a substantial element of uncertainty, novelty and innovation;
• a well-defined project design;
• a report on the procedures and results of the projects.

Previous definition:

“Research and development (R&D) is systematic investigation carried out in the natural and engineering sciences by means of experiment or analysis to achieve a scientific or technological advance. 

Research is original investigation undertaken on a systematic basis to gain new knowledge. 

Development is the application of research findings or other scientific knowledge for the creation of new or significantly improved products or processes. If successful, development will usually result in devices or processes which represent an improvement in the "state of the art" and are likely to be patentable.”