SR&ED Project Definition - Principles

Q and A sheet for project definition paper

Background

This document is designed to present the consensus of the Steering Committee, which includes sector representatives and Canada Customs and Revenue Agency (CCRA), regarding what constitutes a SR&ED project for tax credit claims. This document contains principles that will assist in the application of Information Circular 86-4 as it relates to the definition of a SR&ED project.

What is a SR&ED Project?

A SR&ED project must fall within the definition of SR&ED contained in subsection 248(1) of the Income Tax Act. Such a project comprises a set of interrelated activities that collectively are necessary for the attempt to achieve the specific scientific and/or technological advance(s) defined for the project, are required to overcome scientific and/or technological uncertainty, and are pursued through a systematic investigation by means of experiment or analysis performed by qualified individuals. The project's success or failure is not a factor in determining its eligibility.

Thus, there are three criteria that must be met for any project to be scientific research or experimental development: scientific and/or technological advancement, scientific and/or technological uncertainty and scientific and/or technical content.

The characterization of a SR&ED project should relate to the scientific and/or technological objectives of the project, as they translate into the claimant's business perspective.

It is clearly recognized that a SR&ED project can be purely experimental development or purely scientific research or both.

Subsection 248(1) of the Act defines experimental development as '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'.

Projects should be assessed in their entirety, rather than broken up into their constituent parts, to determine their eligibility since industry sees many projects as a large, long-term undertaking.

Many Canadian companies are part of a global network of corporations. The projects in which they participate may be distributed not only in time across a number of years but also among many national participants. The Canadian corporation may be executing only one phase or stage of such a project or contribute to the full project. When the contribution of a Canadian claimant meets all three criteria, that contribution is recognized as SR&ED.

SR&ED Project Definition

Sector-specific committees have examined several aspects of the question of project definition. Each sector looked at CCRA's three criteria for defining a SR&ED project: scientific or technological advancement, uncertainty and content. Sectors reported as well on commentary regarding the start and end dates of a project and the scope of a project.

Our objective in identifying these types of projects is to establish that 'projects' exist at the highest level, as defined by the claimant, as long as the effort captured by the project is commensurate with the work required to meet the three qualifying criteria for SR&ED. This requires that appropriate internal and accounting methods are sufficient to support the allocation of costs to the project.

With this as a preamble, 'projects' can be defined as falling into one of two 'types' to be recognized by technical reviewers (Science Advisors or consultants) as 'SR&ED projects'. These include:

1) Distinct and well defined individual projects that have a clear beginning and end and a set of well defined specific scientific and/or technological objectives and uncertainties. These are the types of projects that the current technical reviewers are most familiar with at present.

2) Larger and long term multi-year projects that will contain a number of interrelated activities that may include some or all that involve routine development, routine engineering, routine programming, design etc. The activities are characterized by the fact that they are an integral part of the larger project and commensurate with its needs. These activities will not necessarily qualify as stand alone independent SR&ED projects and they will be qualified for the most part by virtue of their contribution to the overall project.

Many companies have dedicated R&D departments or groups that conduct SR&ED projects as their sole or primary business focus. The work of such a group, when it consists of a set of interrelated activities, can be described and treated as a single SR&ED project at that higher level. Other companies may be small, startup companies that are spending virtually all of their efforts in the R&D area in their startup years. It is expected that these groups can clearly define the majority of their activities to qualify as SR&ED. Recognizing the above qualifying SR&ED 'projects', the practice by which projects are divided into smaller and smaller parts will be avoided.

Each claimant has the responsibility of establishing how it differentiates industrial SR&ED from non-eligible work. What criteria are used? How are they applied? Who makes these decisions, and what are their credentials for making such decisions? What is their level of understanding of the SR&ED program, and the claims preparation process to be followed? These questions allow the technical reviewer to focus more on reviewing the company's selection process, rather than the individual detailed projects.

Start of a SR&ED Project

In determining the scope of a SR&ED project, the start of a project is defined as that point at which the scientific and/or technological objectives could be defined. Activity conducted as part of standard business practice not needed to define the scientific and/or technological objectives is not part of the SR&ED project.

In work perceived as routine, where problems are not anticipated and are nonetheless encountered, a SR&ED project could commence when these problems are recognized, and the scientific and/or technological objectives are being defined for purposes of overcoming these unexpected complications. However, this paragraph is not intended to preclude the case of hindsight to identify SR&ED projects that may have begun or taken place. In this instance some of the work that was done prior to this recognition may qualify in that, in hindsight, it was an integral part of the SR&ED project. It is recognized that this may occur when smaller R&D performers are not aware of the SR&ED program at the time of carrying out eligible work.

Duration of a SR&ED Project.

The duration of a specific SR&ED project is not a factor in determining overall acceptability. Some projects could extend over several taxation years while others may be short but may carry high risk elements of uncertainty and the scientific and/or technological knowledge gain from these projects may be of great value.

The development of a new or improved product or process can be shown to occur in several stages:

   (a)    The definition of a scientific concept or technological challenges together with a statement of corresponding scientific and /or technological objectives.

   (b)    The definition of a systematic program to achieve the scientific and/or technological objectives defined in (a). As far as possible, this will describe a scientific research or technological development plan and program including various interrelated activities, milestones, and steps along the development path.

We expect that such a plan likely will go through many iterations as the development progresses because of the uncertainties that characterize scientific research or technological developments.

   (c)    The process or product is developed to the prototype or pilot stage for experimental or technical-trial purposes. That is, prototypes are to test the feasibility of the concept or hypothesis. Possibly, the construction of a whole series of pilots or prototypes may be involved, as problems are met and either overcome or bypassed. It may be that, in this phase of the development, the original objectives have to be modified significantly or perhaps even changed entirely, depending on the technological opportunities that become apparent.

   (d)    The product or process is developed to meet the requirements of commercial use or production. This stage may involve activities such as scaling up from pilot plant size to commercial size, certification, or developing an economical means for commercialization. In many cases, the technologically successful prototype may have been fabricated using methods or materials that are too expensive to be practical for commercialization.

   (e)    Commercial use or production.

   (f)    Often, after a product or process is developed and in the stage of commercial use or production, there are activities to provide improvements to product or process. There may also be continuous improvement activities where the main objective is incremental improvements of the technologies and through this, the product or the process.

The above stages are an idealized linear flow of product/process development logic. While the stages are not necessarily described by companies in the format given above, they are nevertheless involved in some manner in many scientific research and technological developments. Variations do exist and are to be expected. For example, the third stage (c) is sometimes bypassed, and the 'prototype' is developed to meet project requirements or objectives. In some cases, the development may consist of systematically constructing a series of prototypes; each incorporating the lessons learned from earlier prototypes.

The work in the first three stages (a, b, c) described above will constitute a SR&ED project. Activities that fall under d or f can also contain eligible work. A key issue is whether there is a scientific and/or technological uncertainty to overcome.

Activities associated with (e) commercial use or production are not eligible as scientific research and experimental development activities.

End of a SR&ED Project

The end of a SR&ED project is defined as that point at which the scientific and /or technological uncertainties related to the previously defined scientific and/or technological objectives are resolved or are deemed to be unresolvable within the business context of the company. In SR&ED, schedules are frequently elastic, scientific and technological objectives often 'grow', and directional shifts do not necessarily constitute the end of one project and the beginning of another project. For project type 2 identified earlier in the section SR&ED Project Definition, it is recognized that it may not be possible to establish project end dates.

When new processes, products and packages move from the status of scientific research or experimental development to commercial use or production, it is sometimes difficult to determine when studies to resolve scientific and/or technological uncertainty have been completed. Commercialization or Certification may not necessarily indicate the completion of the SR&ED project. A project is complete when the activities associated with resolution of the scientific and/or technical uncertainty are complete and demonstrate that the project objectives have been met.

If the primary objective of the SR&ED project is to make further scientific and/or technological advances in the product or process, then the work is still part of the SR&ED project. If, on the other hand, the technological character of the product or process is substantially set, and the primary objective is to develop markets, to do pre-production activity, or to get a production or control system working smoothly, then the work is no longer part of the SR&ED project. However, if scientific and/or technological uncertainty exists under these circumstances, then work on studies to resolve the scientific and/or technological problems may still be part of the SR&ED project.

Q and A sheet for project definition paper