September 18, 2013
CRA Draft Examples of Eligibility of Work for SR&ED ITC’s
On September 18, 2013 the CRA issued a draft document containing 10 projects as examples to illustrate key concepts.
The CRA begins this paper with the qualifying statement, “These examples are intended to illustrate specific concepts found in the Eligibility of SR&ED Investment Tax Credits Policy. The field of work described is not an issue, nor whether the work is actually eligible.” It is, therefore, important to realize that this document examines specific components of the projects without clearly defining “standard practice” methodology, project objectives, aspects of uncertainty, or experimentation variables.
Example 1 demonstrates the difference between a technical problem (not eligible SR&ED) and a technological uncertainty (eligible SR&ED).
Example 2 shows that technological uncertainties may arise from limitations in current technology, and technological uncertainty exists when it is not known whether a given result or objective can be achieved or how to achieve it based on generally available scientific or technological knowledge or experience.
Example 3 shows that cost targets are not technological uncertainties, but a technological uncertainty may arise by trying technologically uncertain paths to solve a problem to meet the cost targets.
Example 4 shows standard practice, which means applying known techniques to a new situation where it is reasonably certain that the technique will achieve the desired result.
Example 5 illustrates the concept of formulation of a hypothesis to resolve a problem.
Example 6 shows that when a series of tests are executed without any systematic plan and no attempt is made to analyze the results from each test, it is considered trial and error. Such work is not scientific research and experimental development (SR&ED).
Example 7 shows how creating new materials, devices, products, or processes, or improving existing ones, can be achieved with or without technological advancement.
Example 8 illustrates the concept that only the amount, size, extent, or duration of work that is necessary for and directly in support of the basic research, applied research, or experimental development work undertaken in Canada is eligible.
Example 9 shows that it is the purpose of the work, rather than the nature of the work, that distinguishes support work from excluded work.
Example 10 shows that an SR&ED project usually occurs as a subset of a company project.
The full text of the examples follow.
Example 1 — Illustrating concepts from paragraph 3, section 2.1.1 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows the difference between a technical problem and a technological uncertainty.
Case 1 — Technical problem
A chemical company is developing a new process for producing one of their chemical products. One of the components of the process is a series of pumps. However, the pumps started corroding after six months rather than after the expected life of 10 years. The pump supplier was contacted about the problem. They carried out an investigation and traced the problem to an intermittent leak in a filter that allowed corrosive liquid into the unit. The problem was corrected by replacing the filters in the pumps.
In this scenario, the problem with the pumps in the new process was technical and not technological. The technical problem was resolved using standard practice (the company’s trouble-shooting procedures) to find the cause of the corrosion and the problem was solved by replacing the filters.
Case 2 — Technological uncertainty
Consider a different scenario where a set of pumps fails after six months rather than after the expected life of 10 years. The pump supplier was contacted about the problem. They investigated by following their trouble-shooting guide and found that the failure was due to a leak in the seal on the shaft of the pump, which allowed corrosive liquid into the unit. They replaced the seals in all the pumps, but the pumps failed again after six months. Again, the pump supplier found that the cause of the failure was the same.
They investigated further and discovered that the temperature of the shaft after a prolonged period of operation exceeded the maximum recommended operating temperature of the seal material. They also found that the failure of the seal was partly caused by the design of the seal on the shaft as well as the material used for the seal. Under prolonged operation, the seal failed and allowed the corrosive liquid into the unit.
Once the cause of the problem was discovered, the supplier began an experimental development project to find out which of several redesigns of the seal and seal materials would be compatible for the operating environment of the pump. Data on the behaviour and physical properties of the seal materials at much lower temperature ranges were available from the manufacturers. However, there was no information or data available on the corrosive behaviour of materials or their physical properties at the elevated temperatures in the environment that the pump is operating. The supplier undertook a series of experiments to investigate the material behaviour and seal design.
In this scenario, the pump supplier faces technological uncertainties (design of the seal and material behaviour at operating conditions) and undertook experimental development work to resolve them.
This example illustrates the difference between a technical problem that can be resolved by applying practices, techniques, or methodologies that the company knows about or that are
available in the public domain, and a technological uncertainty that requires experimental development.
Example 2— Illustrating concepts from paragraphs 1 and 2, section 2.1.1 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows that technological uncertainties may arise from limitations in current technology, and technological uncertainty exists when it is not known whether a given result or objective can be achieved or how to achieve it based on generally available scientific or technological knowledge or experience.
The current technology of extracting oil from oilseeds is based on a batch process, in which seeds are crushed, conditioned, and flaked. The residue after removing the oil consists mainly of protein-rich flour and seed coats with some trapped oil. This residue (or meal) is then ground and the remaining trapped oil is extracted with a solvent. The solvent is recovered from both the meal and the extracted oil by toasting and distillation. The meal is generally sold as an animal feed product.
The main limitation of the current technology is that the meal is a mixture of the protein-rich flour and seed coats. Seed coats have no nutritional value, and are visually undesirable as a potential ingredient in foods for human consumption. Also, the conditioning and flaking at 80- 100°C harms the nutritional value of the oil and the flour. Therefore, there is a need to develop a low-temperature oil-extraction process, including separating protein-rich flour from seed coats, to produce a protein-rich product suitable for human consumption.
The specific technological problem is how to separate the seed coats from the protein flour at low temperature. It is difficult to physically separate seed coats and protein flour because they have very similar physical properties and the protein flour is firmly bonded to the seed coats
Though there were several technologies available to separate solid particles with different physical properties, no effective low-temperature technologies were available to separate solid particles with very similar physical properties where the particles themselves were bonded together.
One technology which had been tried at a small scale was ultrasonic maceration. However, since there was no publicly available information on the use of ultrasonic maceration for this particular type of oilseed, the operating parameters needed to test the technology were not in the public domain. Also, it was not known whether the continuous process needed on a large scale, including the ultrasonic maceration and simultaneous solvent extraction, could be developed. There was technological uncertainty in developing a continuous method to process oilseeds at low temperatures because no one knew whether the objective could be achieved and how to achieve it.
Example 3 — Illustrating concepts from paragraph 5, section 2.1.1 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows that cost targets are not technological uncertainties, but a technological uncertainty may arise by trying technologically uncertain paths to solve a problem to meet the cost targets.
A company wants to develop an air recirculation system for energy-efficient homes that will permanently remove carbon monoxide. A key component of this system is a module in which carbon monoxide (CO) is converted to relatively harmless carbon dioxide (002) at room temperature.
A process is available that uses a tin oxide and platinum catalyst to convert CO to CO2 at room temperature, and the company could develop a product based on this process. However, the high cost of using this process will make the selling price of the product out of reach for consumers. There are other methods to convert carbon monoxide, but they are not effective at room temperature. A key requirement is that the module must operate at room temperature.
To achieve the project objective (a room-temperature carbon monoxide remover), the company has to develop an inexpensive process that operates effectively at room temperature. The technological uncertainty relates to how to convert CO to CO2 at room temperature that does not use the costly process with tin oxide and platinum.
Although the cost target by itself is not a technological uncertainty, a technological uncertainty may arise from the need to avoid using a costly process, even though that process is known to work. The required cost target is also the motivation or reason for the company to undertake work to remove this uncertainty.
Example 4 — Illustrating concepts from paragraph 10, section 2.1.1 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows standard practice, which means applying known techniques to a new situation where it is reasonably certain that the technique will achieve the desired result.
After testing a newly developed plant variety, a greenhouse grower feels that there is a chance for commercial success and attempts to-find the optimum conditions to maximize production.
Depending on the zone size that can be controlled in the greenhouse, anywhere from 2 to 10 acres is planted with the promising variety. The grower monitors the growth of the crop and, depending on its performance, makes adjustments to guide the crop to optimal production. These adjustments are often called the “development of cultural management strategies or crop husbandry strategies.” However, greenhouse growers are aware of optimization techniques for factors such as lighting, temperature, CO2 and humidity. Also, developing and implementing management protocols for controlling nutrient levels, de-leafing, thinning, and other operational practices are familiar to them.
These well-known and practiced techniques are standard in this industry, as growers are reasonably certain that the techniques, data, and procedures, when applied in this case, would work. So, although the grower may not be certain of the specific parameters, determining them using these approaches is part of the standard practice of this industry. In this case, there is no scientific or technological uncertainty in determining the optimum conditions to maximize production of a new plant variety.
Example 5 – Illustrating concepts from paragraph 1, section 2.1.2 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example illustrates the concept of formulation of a hypothesis to resolve a problem.
The research and development (R&D) department of a company was asked to come up with a solution to improve the bond strength of their premier glue product to compete with another product.
The R&D chemist who was assigned to the project recently came across a published research paper whose authors had used an additive (acting as bonding agent) to increase the bonding strength of two chemicals that belong to the same class of materials as used in the company’s premier glue product. However, the conditions (temperature, pressure, humidity) under which the authors used the additive were quite different than those used by the company in manufacturing the glue. The chemist carried out further searches in both scientific and technical publications on the use of this additive but found nothing more. There was no way of predicting whether the additive would work in enhancing the bond strength of the glue considering the conditions under which the glue was manufactured.
The chemist hypothesized that, based on the similarity of the chemical properties of the glue ingredients and the two chemicals used in the research paper, the use of the new bonding agent in the manufacture of the glue under the right conditions should increase the bond strength of the glue.
This example simply illustrates the concept of a hypothesis—an idea, consistent with known facts, that serves as a starting point for further investigation to prove or disprove that idea.
Example 6 – Illustrating concepts from paragraph 7, section 2.1.3 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows that when a series of tests are executed without any systematic plan and no attempt is made to analyze the results from each test, it is considered trial and error. Such work is not scientific research and experimental development (SR&ED).
A company that has been involved in preparing food products for several years wanted to develop a low-calorie pocket pizza product. They proceeded by attempting to create the low-calorie pizza based on their knowledge of preparing standard pizza products.
In their first attempt, they used different amounts of sauce, reduced the amount of cheese, and replaced the regular pepperoni with low-fat turkey pepperoni, without changing the layer structure of the pizza. This attempt was considered a failure because the low-fat pepperoni burned during cooking.
The next series of attempts involved preparing and testing a different order of layering the ingredients. This attempt also failed because the large size of the pieces of pepperoni led to undercooking. The third attempt reduced the size of the pepperoni pieces by half. This attempt was somewhat successful, but still not good enough. The fourth attempt reduced the thickness of the low-fat pepperoni pieces. This fourth attempt was considered a success and the company proceeded to commercialize the product.
The only lesson learned from each attempt was that it failed. There was no work at any stage to analyze the results from each trial and take corrective action based on the results. In other words, there was no planned approach, including identifying a technological uncertainty, formulating a hypothesis to eliminate that uncertainty, testing the hypothesis, analyzing the results to draw conclusions, and carrying out more experimentation, if needed. The work described in this example is trial and error.
Example 7 — Illustrating concepts from paragraph 4, section 2.1.4 Eligibility of Work for SR&ED Investment Tax Credits Policy
The following example shows how creating new materials, devices, products, or processes, or improving existing ones, can be achieved with or without technological advancement.
The basic design of the potato peeler has not changed for more than 100 years. A company decided to develop a novel peeler by adding a phosphorescent substance to the plastic handle so that it would be easier to find in a dark kitchen drawer. There was no change to the shape of the handle or to the blade. Adding the phosphorescent substance did not entail any change to the molding process and did not affect the physical properties of the handle or the performance of the peeler. While this was a new product, there was no technological advancement in creating this “glow-in-the-dark” peeler.
The same company wanted to develop a new potato peeler with the same blade but wanted to modify the handle to make it easier to use. The new handle would be larger, easier to grip, and less likely to slip in the hand of the user. This would be achieved by making it softer yet rigid enough to retain its shape, and its surface would have to be rough enough to prevent it from slipping in a wet hand. It would also have to be dishwasher safe.
The company found that their requirements could not be satisfied with any plastic that was available at the time. They decided to try to use a new polymer.
In developing the new handle, they encountered difficulties in the injection molding process. Using the new polymer in their existing molding process did not produce a handle with the desired physical properties. The company found that the working temperature for the new polymer had to be much higher than what the current molding process was designed to operate at. Eventually, a new injection molding process had to be developed that used the new polymer to produce the product that had the desired physical properties. The acquired know-how to develop the new injection molding process represented a technological advancement for the company.
New products hit the market every day. This example shows that creating a new or innovative product does not necessarily mean that SR&ED work was done.
Example 8 — Illustrating concepts from paragraph 2, section 2.2.1 Eligibility of Work for SR&ED Investment Tax Credits Policy
The following example illustrates the concept that only the amount, size, extent, or duration of work that is necessary for and directly in support of the basic research, applied research, or experimental development work undertaken in Canada is eligible.
A company produces field-hockey sticks in large numbers to supply the world market. The production stage of the sticks mainly consists of a machine that accepts pre-cut lengths of timber and produces the cut forms for further processing.
The company started a project involving experimental development work to integrate an advanced scanning and laser cutting technology to cut and rasp hockey sticks in a single machine. Based on statistical analysis and their in-house knowledge of the existing machinery, the company determined that 500 sticks from the cutting and rasping machine would generate sufficient out-of-tolerance sticks to test and validate, with 95% confidence, that the development could be considered complete and successful.
The company, on receiving a large order, produced 2,000 sticks.
In this case, the testing and data collection associated with cutting and rasping the first 500 sticks is commensurate with the needs and directly in support of the SR&ED work.
Example 9 – Illustrating concepts from paragraph 4, section 2.2.2 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows that it is the purpose of the work, rather than the nature of the work, that distinguishes support work from excluded work.
In a chemical plant, one of the daily duties of a lab technologist is to take samples from various points throughout the process, perform various analytical tests, and then enter the results into the plant’s database. This database is used by many facets of the organization to monitor, optimize, and control the process.
A research chemist for the company accesses the plant database and uses the data in a research project (assume that this is an SR&ED project). Although the data collected and entered into the plant database is useful to (and used for) an SR&ED project, the data collection and testing performed by the lab technologist are done routinely and not specifically for the SR&ED work. In this case, the daily data collection and testing are considered routine data collection and routine testing and cannot be claimed as part of the SR&ED project.
A research chemist is carrying out an SR&ED project. Much of the data being used again comes from the plant database. Here, however, the researcher also asks the lab technologist to collect specific samples and run specified tests over and above the work that the technologist routinely performs on a daily basis. For this particular research work, the chemist uses both the data and the results from the daily work of the technologist, as well as the specific work he requested from the lab technologist. In the context of SR&ED, the data collection and testing that the technologist carries out specifically for the chemist’s research project are directly in support of SR&ED. However, the data collection and testing the technologist performs on a daily basis, as in case 1, are routine data collection and routine testing and are excluded from the SR&ED project.
This example shows how the same type of work—collecting and analyzing samples in a commercial process—may or may not be SR&ED work depending on the purpose of the work being done.
Example 10– Illustrating concepts from paragraph 2, section 3.2 Eligibility of Work for SR&ED Investment Tax Credits Policy
This example shows that an SR&ED project usually occurs as a subset of a company project.
A company wanted to develop an improved electronic product by incorporating a specific component that would add a new functionality. The company prepared a project plan including budget, created a new cost centre, and allocated staff to work on the project. The company then proceeded with the technological feasibility study, preparing the technical specifications, designing, building the prototype, testing, and making the final incorporation of the component into the product before starting the commercial production, marketing, and sales. In this case, the company project encompasses all the activities from initial idea to final product launch.
During development, a problem arose with the size of the new component in relation to the size of the existing product. Knowledge of miniaturization in the field of microelectronics was required to fit the new component into the existing product. The company did not possess that knowledge. As a result, the company contracted out the miniaturization work. The contractor performed SR&ED work on behalf of the company. The work succeeded in reducing the size of the specific component so that it would fit into the current product. Once the specific component was successfully developed, it was incorporated into the existing product without any difficulty and the rest of the development was accomplished by standard practice.
In this example, the SR&ED project encompasses the work done to miniaturize the specific component, which is a subset of the overall company project.