THIS CASE STUDY EXEMPLIFIES THE APPLICATION OF KEY LEGISLATIVE REQUIREMENTS FOR ELIGIBLE SR&ED ACTIVITIES AS THEY APPLY TO RELEVANT ACTIVITIES IN THE MANUFACTURING INDUSTRY.
Wino Incorporated (Wino) is a specialist in the field of wine cellar refrigeration. In 2017, Wino was approached by a vineyard to create a solution that would allow them to reduce their operating cellar temperatures from 59℉ to 54℉.
A solution was devised to use the cold liquid CO2 from a CO2 recovery plant by vaporizing the liquid and processing it through the cooling units in the cellar to lower cellar temperatures to 54℉.
To qualify for the Scientific Research and Experimental Development Tax Incentive Program, Wino had to make sure its activities met the definition of “scientific research and experimental development” in subsection 248(1) of the Income Tax Act (see Commentary below). After self-assessing, Wino declared the following experiments as SR&ED work.
WINO’S ELIGIBLE SR&ED ACTIVITIES
Design and development of a series of prototypes to achieve the technical objectives and prove the hypothesis (design development and initial testing of the solution to reduce cellar temperatures via a C02 system).
The hypothesis for this phase of Wino’s SR&ED project questioned whether cellar temperatures could be reduced by 5℉ through the use of C02.
At an attempt to prove its hypothesis, Wino conducted the following SR&ED activities:
- Practical design by in-depth analysis of possible issues
- System design was constantly refined over a period of months to improve system performance
- Technical drawings and design calculations were updated as required to incorporate modifications and refinements
- Implementation of solution onsite for testing and further development
Wino proved that the system was a failure as too many variables which were beyond its control did not allow the system to operate in a consistent manner. With all these factors influencing performance, the system was too complicated for stable operation of the cellars.
Trials and analysis of data to achieve results that can be reproduced to a satisfactory standard and to test the hypothesis (testing and assessment of the practical performance revised solution).
Although Wino was unsuccessful in finding a solution to lower the overall temperature in the wine cellar, it was still able to claim the following tests and assessment activities as SR&ED:
- A complete change in design was necessary using CO2 as a conventional refrigerant to reduce the cellar temperature.
- Redesign of the system as a standalone plant using two new compressors and pump recirculation of liquid CO2 to larger evaporators in the cellars.
- A new evaporator in each cellar was added to the existing evaporators.
Background research to evaluate current knowledge gaps and determine feasibility (background research for the design of a solution to reduce the cellar temperatures).
Wino’s background research was focused on identifying issues, designing a potential solution using C02 recovery tanks and liaising with the client for design development. Design development included:
- Client meetings, submission of typical designs, other system options and the undertaking to provide refined designs.
- Internal design development and the development of sketches and calculations.
- Discussions with the site operators on system practicality.
- Design submission to the client for their review and acceptance.
These background research activities were necessary because they assisted in identifying the key elements of the research project, therefore qualifying as SR&ED work.
Ongoing analysis of customer or user feedback to improve the prototype design (feedback SR&ED of the solution to reduce cellar temperatures via a CO2 system).
Wino conducted the following activities during its analysis:
- Development and modification to interpret the experimental results/observations and draw conclusions that served as starting points for the development of new hypotheses; i.e. solutions to observed inefficiencies or problems
- Assessment of client feedback to improve on design of system
- Client inspection on completion of construction stage
- Validation of the design inputs on operation and testing of the new system
These activities were necessary to evaluate the performance capabilities of the new design in the field and to improve any flaws in the design.
To qualify, the work must meet the following definition of “scientific research and experimental development” (SR&ED), as defined in subsection 248(1) of the Income Tax Act.
“Scientific research and experimental development” means 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 or 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.
WHAT RECORDS AND SPECIFIC DOCUMENTATION DID WINO KEEP?
Similar to any tax credit or deduction, Wino had to save business records that outlined what it did in its SR&ED activities, including experimental activities and documents to prove that the work took place in a systematic manner.
Wino saved the following documentation:
- Progress of project (e.g. meeting notes, minutes, emails, reports)
- Conceptual sketches and technical drawings
- Photographs of completed models
- Testing protocols
- Results or records of analysis from testing / trial runs
- Tax invoices
By having these records on file, Wino confirmed that it was “compliance ready” — meaning if it was audited by the CRA, it could present documentation to show the progression of its SR&ED work, ultimately proving its SR&ED eligibility.