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 Aerospace/Steering Committee
Corp.