Recognizing Experimental Development

Introduction

The SR&ED Program has evolved since its creation in 1985. Although there have been numerous changes to the legislation, the clarification of the definition of experimental development that was made in 1992 is of particular importance to the application of eligibility requirements. The clarification was that experimental development is work performed with the intent to achieve a technological advancement for the purpose of creating new, or improving existing, materials, devices, products, or processes, including incremental improvements.

This document was prepared by a group of industry participants and Canada Customs and Revenue Agency (CCRA) to develop a set of key concepts that can contribute to an objective recognition of experimental development. The concepts are based on principles embodied in the law and reflect the government's intent of the SR&ED Program.

In preparation for drafting this document, the group reviewed the law, historical background, and various Information Circulars to ensure that the comments below are consistent with the principles embodied in the law and reflect the government's intent of the SR&ED program. The comments in this document complement and clarify key concepts set out in IC 86-4R3. A description of the drafting group and a listing of background documents reviewed are provided in the appendix.

The Law - What is Scientific Research and Experimental Development (SR&ED)?

The law (in subsection 248(1) of the Income Tax Act) defines SR&ED as:

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

(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(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,

and, in applying this definition in respect of a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where the work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b) or (c) that is undertaken in Canada by or on behalf of the taxpayer,

but does not include work with respect to

(e) market research or sales promotion,

(f) quality control or routine testing of materials, devices, products or processes,

(g) research in the social sciences or the humanities,

(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,

(i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,

(j) style changes, or

(k) routine data collection."

Experimental Development Key Principles

Based on the definition of experimental development in the law and the review and discussion of the reference documents, the following principles have been identified as key considerations in the recognition of experimental development:

• Experimental development is the attempt to achieve technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements.
• In experimental development, the objective is the achievement of technological advancement, whereas in basic and applied research the objective is the advancement of scientific knowledge. In either case, there is no requirement that the attempt be successful.
• Experimental development follows a systematic investigation or search by experiment or analysis in a field of technology.
• Experimental development is typically carried out in a commercial setting.
• The technological advancement can be either embodied in the new or improved materials, devices, products or processes, or represented by the technological know-how gained.
• An attempt to resolve technological uncertainty is an attempt to achieve technological advancement.
• The technological advancement sought must be identified within the business context of the taxpayer.
• Work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research is included as experimental development if it is "directly in support" of and "commensurate with the needs" of the experimental development being undertaken.
• Work that directly contributes to the attempt to achieve a technological advancement is experimental development regardless of what the work is called
• Experimental development excludes work defined in paragraphs 248(1)(e) through (k) of the definition of SR&ED.

Discussion of key concepts

Distinction between experimental development and basic and applied research

The clarification of the definition of experimental development in 1992 was intended to focus on the purpose of experimental development. Experimental development is the attempt to achieve technological advancement in the context of creating new or improving existing materials, devices, products or processes. On the other hand, basic and applied research are undertaken to advance scientific knowledge. The clarification to the definition in 1992 was not a change in tax policy.

What Does Achieving Technological Advancement Mean?

In experimental development, a technological advancement is sought for the purpose of creating new or improving existing materials, devices, products or processes. It is important to note that the definition of experimental development does not refer to the success or the failure of the systematic investigation or search. The law only requires an attempt to achieve a technological advancement. What this means is that the result, i.e. success or failure of the work, is irrelevant in determining whether or not the work undertaken meets the definition of experimental development. What is relevant is the work performed in attempting to achieve technological advancement.

Gaining technological know-how for the purpose of creating a new, or improving an existing, product or process often precedes the scientific understanding of the technological advancement. A gain in knowledge that advances the understanding or application of the technology involved i.e. know-how, (for example, new or improved practices, methodologies, or techniques) also represents a technological advancement.

In the context of the above discussion, seeking a technological advancement means attempting to increase the technology base or level of the taxpayer from where it was at the beginning of the systematic investigation or search. The business context of the taxpayer must be taken into consideration when determining if there is an attempt to increase the technology base. Specifically, the technology base in the business context refers to the technological resources (i.e. the existing level of technology, technological "know-how", and personnel experience) that are reasonably accessible within the capabilities of the taxpayer from both internal and external resources.

Training and on-the-job learning based on available know-how does not meet the requirement of achieving a technological advancement.

The development work must be viewed at the highest possible level to properly recognize the technological advancements attempted which define the full scope of eligibility. The definition of experimental development in 248(1)(c&d) (as presented above) uses the collective noun "work" to capture all the effort. This does not mean that all development work is experimental development work; support work of the kind listed in 248(1)(d) must be "directly in support" of and "commensurate with the needs" of the experimental development being undertaken. Work defined by paragraphs 248(1)(e) through 248(1)(k) is excluded. It is important to reiterate that it is not what the work is called but that all work that contributes to the effort to achieve a technological advance is included as experimental development.

As experimental development work can span a number of years, a snapshot of the work in a given year may not reflect the overall effort to achieve technological advancement. Once it is established that a technological advancement is being sought, work in any year that directly contributes to or supports the attempt is part of the experimental development.

It is important to recognize that processes should not be restricted to machinery or the manufacturing environment. Technological advancements can be made in situations where new or improved technologies are being sought to improve business, industrial and other processes.

When the material, device, product or process being developed is a technology, then the technological advancement can be measured in the increase in know-how or in the improved capability or performance of the material, device, product or process not available previously. The experimentation, analysis and associated work that contributes to the attempt to improve the capability or performance of the material, device, product or process is experimental development.

Achieving a Technological Advancement in a Commercial Setting

Technological advancement for the purpose of creating new, or improving existing, products or processes typically occurs in a commercial environment. Experimental development work can be jointly associated with commercial work; it is irrelevant whether experimental development is conducted in a commercial setting and/or is part of the commercial work.

Relationship between Technological Advancement and Technological Uncertainty

In experimental development, the work is directed at achieving technological advancement. It is implicit that a technological uncertainty exists when there is an attempt to achieve technological advancement. The existence of technological uncertainty drives attempts to achieve technological advancement. If the attempt, regardless of whether it is successful or not, seeks to resolve technological uncertainty then it has satisfied the technological advancement requirement.

In general, it can be said that technological advancement is inherently linked to technological uncertainty and arises out of the attempt to resolve the technological uncertainty. For example, at the start of an experimental development project, the objective may be to overcome a technological uncertainty. Along the way, any progress made in overcoming this technological uncertainty is a step closer to achieving a technological advancement. In other words, the same work resolves the technological uncertainty as well as advancing the technology concurrently.

In summary, attempts to resolve technological uncertainty through a systematic investigation or search by experiment or analysis will result in a technological advance. Therefore, attempts to achieve technological advancements and to resolve technological uncertainties occur simultaneously.

When the technological advancement is evolutionary, it may be difficult to recognize incremental improvement as technological advancement. In such situations, it would be useful to establish the technological advancement by examining the attempt to resolve the technological uncertainty. If possible, it could be helpful to follow the evolution of a product's capabilities or performance over a number of years to recognize incremental improvement.

Work commensurate with the needs and directly in support of Experimental Development

Any of the following work:

• engineering;
• design;
• operations research;
• mathematical analysis;
• computer programming;
• data collection;
• testing; and
• psychological research

is also experimental development if:

• it is commensurate with the needs,

and

• it is directly in support

of the taxpayer's experimental development undertaken in Canada.

The expression "commensurate with the needs" refers to the amount of effort that is needed in the attempt to achieve the technological advancement or to resolve the technological uncertainty.

"Directly in support", means if it is needed in attempting to achieve the technological advancement or attempting to resolve the technological uncertainty.

Systematic Investigation

Experimental development must be a systematic investigation or search by experiment or analysis. The existence of a process for doing the work will normally demonstrate the requirement of a systematic investigation or search has been met. The business or operational context of the company is a major factor in the decision of whether the process followed was a systematic investigation.

Any one of the following is indicative of the existence of a systematic process:

• the work is carried out or led by trained or experienced personnel;
• the work is conducted under a development protocol or under the direction of a project manager;
• the work is documented; or
• the process by which the work is performed is documented.

Even if these are not present, there may be other equally valid indicators of a systematic investigation.

Appendix

References:

1. 1985 Budget Papers - Securing Economic Renewal- tabled in the House of Commons by the Honourable Michael H. Wilson, Minister of Finance, May 23, 1985.
2. Appendices C - F of Information Circular IC 86-4R2 - Description of the process of guideline development.
3. News Release of December 2, 1992 - Modifications to the Scientific Research and Experimental Development Tax Incentives - by the Minister of Finance, Don Mazankowski.

The Eligibility Drafting Group was formed to prepare guidelines and clarification documents for the SR&ED Action Plan Steering Committee. The primary function of the committee is to oversee implementation of the action plan developed in response to the recommendations put forth at the June 1998 SR&ED Conference Building Partnerships.

Membership of the Eligibility Drafting Group

Member	Affiliation	Sector
Gregory Brennan	KPMG	Oil & Gas/Small & Medium Enterprises
Shelley Cameron	Ericsson Canada Inc.	Telecommunications
Roger Fortin	Ericsson Canada Inc.	Telecommunications
Gerry Goodchild	CCRA	CCRA
Ron Horn	Nortel Networks	Telecommunications/Steering Committee
Jim Lanigan	DaimlerChrysler Can. Inc.	Automotive
John Michaelides	Robin Hood Multifoods Inc.	Food and Consumer Packaged Goods
Russ Roberts	CATA Alliance	Software/Advisory Committee
Daniel C. Simard	Merck Frosst Canada & Co.	Pharmaceuticals
Kia Tan	CCRA	CCRA
Peter Van Die	CCRA	CCRA
Tony Yee, chairman	Pratt & Whitney Canada Corp.	Aerospace/Steering Committee