Standard Practice Software Development: Hypercube Inc vs. Her Majesty The Queen

Hypercube Inc vs. Her Majesty The Queen demonstrates how the CRA apply standard practice or routine engineering to deny weak software development claims.


I’ve broken down the case by the Five Criteria established by Judge Bowman in the case of Northwest Hydraulic Consultants Ltd. v. Canada which is commonly referred to by the Tax Court.

1. Was there a technological risk or uncertainty which could not be removed by routine engineering or standard procedures? 

The project,

 consisted of developing a program to read and analyze source code from Web sites to detect weaknesses

This was to be a web crawler designed to replace a manual process of analyzing website code and provide a report to help programmers do their checks.

The Judge referenced the facts:

[18] Mr. Villeneuve noted that no existing technology allowed this to be done. Current technology, he explained, could not collect the information, validate it and retrieve it in the way they wanted it to. Mr. Villeneuve stated in his testimony that the program would improve the underlying technology. He described the underlying technology as being various programming languages.

[21] Regarding the technological uncertainties facing the appellant, Mr. Villeneuve stated that they were connected with the underlying technology. The uncertainties related to whether the underlying technology could be improved so that a crawler could be programmed as required to carry out the project.

Available languages may be a limitation but Improving programming languages seems to be beyond the scope of creating a new web crawler. Additionally, it is contradicted by an earlier statement that suggest the project started when the required tools were available :

[11] Mr. Villeneuve stated that he began thinking about this project in 2010 and discussed it with the appellant’s other employees around the beginning of 2012. Page: 3 The project was the product of a reconsideration of the various programming tools available.

2. Did the person claiming to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?

The hypothesis established by the claimant was that,

if a new way of performing Internet diagnostics was adopted, significant effects in terms of technological advancement could be observed”.

This isn’t a scientific hypothesis as it does not propose a “new way” and does not postulate an effect.

3. Did the procedure adopted accord with the total discipline of the scientific method including the formulation, testing and modification of hypotheses?

The work described failed to demonstrate any modifications of the hypothesis:

[20] Mr. Villeneuve explained that the project was carried out methodically, using a process of [TRANSLATION] “trial and error”. The appellant’s employees analyzed whether they could retrieve an initial piece of information in a Web site’s code, validated their attempt and then made another attempt to obtain a second piece of information, and so on.

[22] Mr. Villeneuve then spoke in more detail about what he saw as the problems they experienced in developing the program and explained the various measures taken to resolve them.

[23] An initial problem was that the program did not work for certain domain names that were being used by the Web sites being analyzed. Changes were made to the program so that it would work with all existing domain names.

By explaining the work as a series of problems that were resolved individually only standard programming work was demonstrated.

4. Did the process result in a technological advancement?

While they succeeded in creating a new website analysis tool, the judge applied the following logic:

[47] Although the appellant’s program could constitute an entirely new product, it was created using well-known techniques. Novelty or innovation in a product is not sufficient to illustrate technological advancement.

The claimant failed to demonstrate any new knowledge gained from their work.

5. Was a detailed record of the hypotheses tested, and results kept as the work progressed?

There was little documentation submitted to the court and, as the judge notes, the evidence was not explained.

[48] Moreover, the appellant produced very little evidence documenting its project. The only documents introduced in evidence are the program’s tree diagram and a log of hours worked. This tree diagram was not specifically explained in Court, and the time log does not appear to reflect reality. I do not think that this evidence is sufficient to support an SR&ED claim as prescribed by the ITA.

Documentary evidence could have helped verify the testimony but the claimant had already failed to meet the other criteria.


This case demonstrates poor project framing. The objective was a high level advancement in the “underlying technology”, namely programming languages, but the work was low level resolution of issues. I think the project could have qualified if described somewhere in the middle.  A more feasible advancement would have been an improvement web crawling methods; the underlying technology behind their objective to automate website analysis.  The hypothesis would build on this by stating the web crawling methods they thought could improve the crawlers performance. The experimentation would then focus on more fundamental changes to the web crawling methods and associated variables with any issues encountered classified as support work.


Do you think this project should have qualified for ITC’s? If so, how would you frame it?

The Riskiest Industries to Claim SR&ED

Every SR&ED claim carries risk of a CRA review. But what are the chances of getting the amount claimed after a visit from the CRA? Only 16% of claims were reduced following an audit from 2007-2009; however, some industries had much higher rates. Information revealed in the Muller Report  shows the disallowance ratios of audited claims (for industries with over 100 claims from )

Industry # Claims Ratio
Heavy and Civil Engineering Construction 100 80%
Furniture and Related Product Manufacturing 246 39%
Building Material and Supplies Wholesaler-Distributors 163 38%
Clothing Manufacturing 143 36%
Wood Product Manufacturing 262 36%
Management of Companies and Enterprises 136 35%
Primary Metal Manufacturing 112 30%
Paper Manufacturing 143 29%
Crop Production 336 28%
Animal Production 270 28%
Miscellaneous Wholesales-Distributors 223 27%
Food, Beverage and Tobacco Wholesaler-Distributors 136 27%
Specialty Trade Contractors 326 25%
Food Manufacturing 615 24%
Fabricated Metal Product Manufacturing 908 24%
Electrical Equipment, Appliance and Component Manufacturing 235 22%
Plastics and Rubber Products Manufacturing 440 18%
Support Activities for Mining and Oil and Gas Extraction 106 17%
Repair and Maintenance 263 17%
Overall Average 16%

Almost half of the industries in the list are manufacturing with typically low innovation categories such as clothing, furniture and primary metals near the top and higher tech categories such as electrical and plastics near the bottom. It has been well known in the industry that SR&ED does not favour manufacturing and this data confirms it.

Agriculture is another high risk industry. This probably stems from the difficulty of separating experimental production from commercial in an agricultural environment. The boundaries need to be clearly defined; experimentation entails risk and the CRA does not believe someone would risk their entire crop for an experiment.

Other industries that relate to activities specifically exempt from SR&ED also appear on the list, such as wholesalers, management and oil & gas. Subsection 248(1) of The Income Tax Act states that SR&ED “does not include work with respect to market research or sales promotion, research in the social sciences or the humanities, prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas.  Any activities falling into these categories are easy targets for the CRA. Successful claims tend to fall outside of the companies primary focus and actually fall into sciences such as software, mechanical engineering or robotics.

The highest ranked industry is heavy and civil engineering construction with over twice the disallowance rate of any other industry. This could be partly due to similar reasons as agriculture; the separation of commercial from experimental production but the challenge in construction goes beyond that. Its about risk. Typically the size of projects in this industry mean that only one is built and once that project is built it cannot  fail. In terms of SR&ED this means all the prototyping is done in simulation or modelling which the CRA can classify as due diligence and there are few failures to prove uncertainty.

This is one example of the insightful data available in the Muller Report. Sadly this information is from 2009. Hopefully the CRA will become more open and share data so we can all work to improve the program.

CRA’s Risk Factors for SR&ED claims

The Canada Revenue Agency’s Claim Review Manual for Research & Technology Advisors (RTAs) includes the following risk factors used for selecting SR&ED claims for review:

  • filing history of the claimant;
  • claimant’s compliance history;
  • work described in the project descriptions;
  • sector-specific issues;
  • nature and extent of the non-compliance issue;
  • amount of ITC at risk;
  • opportunity to educate claimant on the requirements of the SR&ED Program and to inform claimant about available claimant services and literature;
  • opportunity to promote self-compliance and proper self-assessment by the claimant;
  • opportunity to obtain a better understanding of the claimant’s work; and
  • effect of either carrying out a review or not carrying out a review on future compliance.

Once selected, the following factors are used to identify high risk projects/activities:

  • Large projects/claims in relation to the industry sector or the claimant’s norm or resources;
  • Projects that seem unusual for the claimant’s business line;
  • Project descriptions that strongly suggest that work is not SR&ED or where the descriptions make it difficult to determine what was done;
  • Indications of lack of separation of SR&ED and commercial activities, particularly where the claim may involve questions of Experimental Production (EP) or Commercial Production with Experimental Development (CP+ED);
  • Projects that are ongoing for many years with no clear end in sight;
  • Historically significant problems with the issue, with the claimant or with other claimants that had similar issues;
  • Issue could affect other issues or other companies with the same issue;
  • The materiality of the issue;
  • Work may have resulted in the creation of a significant commercial asset;
  • Known R&D centres outside Canada; and
  • Issue is material, typically the amount of ITC at risk relative to the total claim.



Pixar’s Rules to Phenomenal SR&ED Reports

I never realized how much writing technical report for SR&ED projects is classic story telling but many of Pixar’s 22 Rules to Phenomenal Storytelling match up well to the SR&ED narrative. For example:

1. You admire a character more for their trying than their success.

In SR&ED terms, this means focus on the project’s failures and the efforts to overcome them instead of just listing accomplishments.

4. Once upon a time there was ____. Every day, _____. One day ____. Because of that, ____. Until finally ____.

This is the SR&ED project structure, for example: Once upon a time there was a company trying to improve their process (uncertainty). Every day they ran the machines the same (standard practice)  One day they experimented with new variables (hypothesis/work done). Because of that they improved production (result). Until finally they realized how the variables affected their process (technological advancement).

7.  Come up with your ending before you figure out your middle. Seriously. Endings are HARD, get yours working up front.

For SR&ED the ending is the advancement. This suggests defining your advancement first then working backwards from their. A great tip that I am going to try applying.

Can you find any other similarities? Does this apply to other industries such as sales. Post a comment and let me know.



What is SR&ED?

By the Numbers:

  • $3.6 billion credits from the federal government and $1 billion from the provinces annually makes SR&ED Canada’s largest business tax credit (1)
  • 18,000 claimants a year
  • 35% of eligible expenses refunded to Canadian Controlled Private Corporations (CCPC) federally (2) with provinces adding anywhere from 10% to 37.5% (3)
  • 18 month deadline from the fiscal year end (4)
  • 120 or 240 day turnaround times (depending on when you file) (5)

What Qualifies?

Any actives undertaken to improve products and/or processes using the scientific method. This can include:

  • Complicated issues that required experimentation to solve
  • Incremental improvements to product/processes
  • Even failed attempts as long as you learned something (6)

You can then claim related :

  • Employee hours (with an overhead bonus)
  • Materials consumed in testing
  • Subcontractors (at a reduced rate) (7)

How To Apply?

To apply, file a T661 form (8) with your corporate tax return. While I have simplified things here, the program is very complicated and always changing (see the citations linked to CRA websites).  If you have any questions fill out the form below and I’ll get back to you.

Some thoughts on the CRA’s SR&ED draft examples

While examining the CRA’s newly release SR&ED examples, I noticed a couple of trends in the content. I’ve attempted to relate these finding to the CRA’s new review approach. Here is what I found:


Technology Reviewers commonly site this as a reason to deny a project.  A report stating that work is standard engineering and not SR&ED can be hard to dispute. The examples reiterate that this strategy will continue. Although only Example 4 explicitly states the example “shows standard practice”, the first 5 (of the 10 examples) relate to standard practice.

How do you prove that your objective could not be accomplished through the use of standard methods or available technology?

First, make sure you have well defined objectives. State the current benchmarks  of the related technology in your industry are and how you you would like to exceed them. On a side note, the objective can be to catch up to a competitor as long as their technology is proprietary.

Second, describe the initial research you did for available solutions. The CRA calls this due diligence (you can’t claim these hours). This includes internet and patent searches, talking to suppliers and other experts, or articles & manuals referenced. Make sure you explain why the available solutions are insufficient. For example, robotics could improve your process but are too expensive, therefore you sought to develop a cheaper solution in-house.

Third, document your findings. The CRA loves documentation and this is an area that is often overlooked. Make sure to save any emails, articles, search results, or other findings when you do your initial research. See my previous post The 5 Documents That Prove SR&ED for tips on documentation.


The remaining examples provided by the CRA focus on the methods applied to achieve your objective. Specifically, they want to know whether you follow the scientific method. The CRA defines this as “an approach that includes defining a problem, advancing a hypothesis towards resolving that problem, planning and testing the hypothesis by experiment or analysis, and developing logical conclusions based on the results.”

In a typical project this translates to selecting the key variables, evaluating alternatives for these variables, testing/prototyping the selected alternatives, and evaluating the results. this process is often repeated until the desired results are achieved or the project is abandoned.

Knowing, following, and documenting this framework makes for a great SR&ED project. Often companies with budgets and deadlines to meet don’t follow this method exactly and that is where a consultant, like me, is useful. Consultants help separate the business work from scientific development and put it into a concise report for the CRA.  Unfortunately, it is still up to you to prepare and save documentation produced during the project.


Focus on following and documenting these 2 aspects and the rest of the project will fall into place.

The 5 Documents That Prove SR&ED

Every SR&ED should be backed by documentation. The CRA often requests documentation to support a project. This can be financial and/or technical information. While financial information tends to be straightforward (financial statements, invoices, etc.), illustrating your technical process can be difficult. By matching documentation to the 5 steps of SR&ED you can ensure all the technical requirements are met.

Step 1a) Define Standard Practice

Before starting a project you probably search to see if there are any readily available solutions to your problem

Internet searches

The first place most people start is Google.  Articles showing that there is no standard practice or knowledge available that solves your problem.

To save the articles you can print to pdf or use a service like Evernote Webclipper. Once saved you can upload the evidence directly to RDBASE.


You may want to search patents to see if there is a product or process similar to what you are trying to create.  Google Patents is a great service that lets you search through millions of patents. Again, when you find something relevant, save & upload.

Inquiries to Experts

If you contact suppliers, customers, or other experts in the field save their response. Experts give a good sense of what knowledge is available to those in the field. Create a SR&ED folder in your email client and keep their responses.

Potential Components

Maybe you’ve found some parts or methods that you might be able to use but they don’t provide the full solution or are too expensive. Save the specs/article and make sure it illustrates why it’s not a full solution.

Competitive Products

Say your competitor has come up with a new product and you want to catch up to them. The solution isn’t readily available because it is proprietary to your competitor. Show what they’ve done and how you want to improve upon it.

Step 1b) Objectives > Standard Practice

Show how you plan to improve upon the current standard.

Look for a document that:

–          Outlines quantified objectives,

–          Discusses what the project is to achieve

–          Is dated near the start of the project

Possible sources of this documentation include:

–          Project planning documents

–          Emails

–          Meeting minutes

–          Design of experiments

Step 2 Uncertainty/Hypothesis

A test matrix or testing plan is a spreadsheet with variables/conditions to be tested as the column/row headers and the results of each test filling the spaces. Example:


Temperature 1

Temperature 2

Temperature 3

Time 1

Result 1-1

Result 1-2

Result 1-3

Time 2

Result 2-1

Result 2-2

Result 2-3

Time 3

Result 3-1

Result 3-2

Result 3-3

Showing how the variables were tested will prove:

– You were uncertain how to meet your objectives,

– had a systematic testing plan in place &

– you had a hypothesis how you could reach your goals.

This is the most important of all the supporting documentation. Not only with this backup all of your activities, it will serve as the starting point for the SR&ED project.

Step 3a) Systematic Investigation

The objective here to illustrate the difficulties you had during the project.

Pictures/video are great for showing issues that occurred on the shop floor. Add notes to the pictures to tie them back to the variables and comment on what went wrong.

Other documentation such as worker logs, time sheets, test data, or results are great to back up the work done and the costs claimed but don’t always prove SR&ED.

Step 3b) Technological Conclusions

This can be the hardest to find because analysis of the results is often in the managers head or discussed verbally. What is required is a document stating what was learned from the experiments in relation to the variables tested. Look for this in:

– in-term or  final reports,

– emails discussing results ,

– or meeting minutes. 


The best thing to do is establish a good documentation practice and follow it during the project. This includes:

–          Monthly SR&ED project meetings/reports

–          A physical SR&ED folder or online storage such as RDBASE

–          An understanding of which documents relate to SR&ED