As described in an earlier post, the Northwest Hydraulic case from 1998 resulted in a new set of criteria in order to determine the existence of SR&ED. The original 3 criteria were expanded into 5 Questions.
The ORIGINAL 3 CRITERIA
- Scientific or technological uncertainty: Technological obstacles / uncertainties are the technological problems or unknowns that cannot be overcome by applying the techniques, procedures and data that are generally accessible to competent professionals in the field.
- Scientific and technical content: A systematic investigation entails going from identification and articulation of the scientific or technological obstacles/uncertainties, hypothesis formulation, through testing by experimentation or analysis, to the statement of logical conclusions. In a business context, this requires that the objectives of the scientific research or experimental development work must be clearly stated at an early stage in the evolution of the project, and the method of addressing the scientific or technological obstacle/uncertainty by experimentation or analysis must be clearly set out.
- Scientific or technological advancement: The search carried out in the experimental development activity must generate information that advances your understanding of the underlying technologies. In a business context, this means that when a new or improved material, device, product or process is created, it must embody a technological advancement in order to be eligible. In other words, the work must attempt to increase the technology base or level from where it was at the beginning of the project.
The 5 QUESTIONS
In theory the determination of eligibility didn’t change after Northwest Hydraulics. However a careful reading of the 5 Questions makes it clear that there is more of an emphasis on the scientific method:
The method to establish if there is SR&ED involves answering five
1. Was there a scientific or a technological uncertainty?
2. Did the effort involve formulating hypotheses specifically
aimed at reducing or eliminating that uncertainty?
3. Was the overall approach adopted consistent with a
systematic investigation or search, including formulating
and testing the hypotheses by experiment or analysis?
4. Was the overall approach for the purpose of achieving a
scientific or a technological advancement?
5. Was a record of the hypotheses tested and the results
kept as the work progressed?
Remember: “It is determined that there is SR&ED if the answer to all
five questions is ‘YES’.”
As you can see, there is a greater emphasis on documentation of the hypothesis, experiments, and the results of tests, than there was in the 3 Criteria described earlier.
BUSINESS PROJECTS vs SR&ED PROJECTS
While the CRA expects that claimants will identify and document SR&ED projects, the reality is that claimants document product development and process improvement projects. These “business projects” include eligible activities, however the eligible portion of development work must first be extracted from the business project.
Typically as practitioners we expect that claimants will do a good job of documenting business projects and managing costs. That only makes good business sense. However documenting SR&ED projects is a different matter.
Most technology companies don’t actually intend to be engaged in SR&ED projects. SR&ED is really a by-product of product development in a quickly changing technological environment.
As SR&ED practitioners we almost always begin by ‘reverse-engineering’ the business projects to identify potential SR&ED. Once potential projects have been identified, we work with development staff, our own technical folks and GOOGLE search to try and determine the base level of technology and try to understand why it wasn’t adequate to meet the company’s business objectives.
Once identified, solving the technological uncertainties becomes a ‘sub-project’ within a larger business project. All we need to do then is to map the activities essential to solve the eligible technological problems, and strip out the ‘routine engineering’ contained in the business project.
The best way to do this is to work with the company’s ‘activity-based costing’ system to allocate costs and activities to the SR&ED project(s).
That might be easy if companies actually used activity-based costing systems.
Instead we need to build our own activity-based system and superimpose it on the claimant’s project management system.
ADEQUATE SR&ED DOCUMENTATION MUST BE ‘CONTEMPORANEOUS’
In the past, CRA recommended that claimants ensure that developers prepare detailed timesheets describing eligible activities. That simply isn’t workable, primarily because timesheets (if used) are tied to business projects – not SR&ED projects. What’s more they’re almost never detailed enough to be of any value.
SOURCE CODE REPOSITORIES
Instead we tend to use the natural tools favoured by software developers and others in managing development projects. For software developers these include software source code repositories and versioning tools like GitHub or Subversion.
These are a natural outgrowth of systematic software development projects, and involve developers logging changes to source code as the work is completed. The associated log files can determine with some degree of accuracy what pieces of source code individual developers worked on – and when.
Another useful source of data is project management software like JIRA, ASANA or HUBBLE. These indicate the intentions of project managers prior to deployment.
Coupling these types of data with detailed payroll records can provide a good substitute for activity-based costing for SR&ED projects. Ideally though, identifying technological uncertainties is best done by technical leads, as soon as they become apparent.