SR & ED – How to document uncertainty and the technology gap ?

The documentation of projects and activities claimed as SR & ED is increasingly important in the claim process. We look at why it is difficult to document the technological uncertainty, especially in the context of experimental development (ED). We propose a simple method to document current practice and “the gap in technology” that will better illustrate this uncertainty.

1- Why is it difficult to document the technological uncertainty

In recent years, the CRA has stressed the importance of documentation as to almost make it a new eligibility criterion. Many written requests for additional information by the CRA these days include a request for examples of project documentation. We have reached the point where the issue of documentation is one of the main obstacles to obtain credits for SR & ED.

1.1 No clear directive

At first glance, this requirement may seem difficult to put in writing. Yet this issue could be resolved to the benefit of everybody if the CRA simply emitted a sort of “standard” that would show to the auditors and taxpayers what is needed to support a SR & ED claim.

Of course, there is Appendix 2 of the “Guide for complete Form T661 – T4088”. But these are only examples. The CRA does not specify what is required, necessary and sufficient.

1.2 The effect of not clearly defining requirements

The fact that the CRA did not provide more detailed written instructions on its documentation requirements means that a CRT can always indicate a “lack of documentation” or “insufficient detail about the work performed and claimed” as a reason to reject a claim. Since there is no written standard or clear test to determine what is necessary, it is almost impossible for a taxpayer to challenge such a decision.

Warrant a negative assessment of SR & ED as “insufficient documentation” is very easy and cost effective for the CRA. It is certainly much more efficient than requiring the CRT a rational and documented explanation of why it considers that there is no technological uncertainty or technological progress.

2- The case of Experimental Development (ED)

Documenting is even more problematic, because most companies claiming SR & ED actually claim experimental development (ED). The initial objective of these projects is usually to create a “product or a new or improved process” but not to create new knowledge. This problem is complicated by the fact that there are two types of required documents:

2.1- Accounting records and time:

This requirement is quite easy to satisfy and most companies can implement a simple process to comply.

• Prove that when working on this project, you have
  • time sheets,
  • contracts and subcontractors’ invoices,
  • frequent reports, and
  • other contemporaneous documents.
• Make sure that the hours worked are detailed by project, activity and employee. You also need a clear explanation supported by facts about the end of the project.
• Use a formal chronology and / or a Gantt chart.

2.2- Technical documents

These documents must corroborate that the activities claimed as SR & ED were actually carried out during the claimed time span.

The documentation of the development of a new product is usually focused on the progress of the project and on meeting the customer requirements and specifications. But this is not the language nor what the RTA is looking for.

It is therefore essential to create specific documentation for the SR & ED project. It will focus on three basic requirements of the CRA rarely documented in a product development project :

1. The standard practice for this technology in this industry has been defined and measured with respect to at least one reference,
2. You must demonstrate that your activities go beyond routine engineering and standard practice. This is to define and demonstrate the gap between what is desired and what can NOT be processed using existing technologies and standard practice knowledge,
3. You also need to characterize the experimental process: the solutions explored, hypotheses generated, experimentation performed, analysis, results and conclusions, and who worked on these activities

3. Documenting the standard practice and the “technology gap”

The CRA requires to demonstrate more than the work done. We must increasingly prove that this work represents a “progress” compared to the “state of the art” (also known as standard practice) of the technology. If this is unsuccessful, the taxpayer may show  excellent proofs of his research, but it still does not satisfy the fifth question to identify if it is SR & ED.

Once this “state of the art” is defined, it is easier to decide which documents represent the “experimental procedure” or activities that are or not part of the SR & ED and why. Although this goes beyond the absolute requirements to claim SR & ED tax credits, it is an effective method to better defend the claim, while paving the way for additional protection of intellectual property.

Establish, define and gather the facts relevant to the “state of the art”. Then you specify what was possible with this technology and compare it to what was necessary or required to realize your project. That’s a key to define the uncertainty encountered in a SR & ED project. We call it “technology gap”.

4- Conclusion

To conclude, the analysis of the technological gap and documents depicting the essential landmarks of the experimental process would normally satisfy the RTA. Note further that the date on which this gap has been identified as a central barrier is often used to establish the beginning of the SR & ED project. You must write and date every documents related to the project and defining this difference in technology.

And you what do you think about this ? How do you define the technological uncertainty in the course of your SR & ED projects? Do you have any tips? Ways or ideas to share about it ? How did the CRA respond to your documentation mechanisms?

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