Date: 19990409
Docket: 97-975-IT-G
BETWEEN:
SAFETY PLUS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Bowman, J.T.C.C.
[1] The issue in these appeals from assessments for the appellant's 1993 and 1994 taxation years, which ended on January 31 in each year, is whether certain activities of the appellant constitute scientific research and experimental development ("SR & ED") for the purposes of sections 37 and 37.1 of the Income Tax Act. SR & ED is defined in part XXIX of the Income Tax Regulations.
[2] The portion of section 2900 of the regulations that is relevant to this case is as follows:
2900. (1) For the purposes of this Part and sections 37 and 37.1 of the Act, "scientific research and experimental development" means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,
...
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view,
(c) experimental development, namely, work undertaken for the purposes of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, or
...
(2) For the purposes of clause 37(8)(a)(i)(B) and subclause 37(8)(a)(ii)(A)(II) of the Act, the following expenditures are directly attributable to the prosecution of scientific research and experimental development:
...
(c) other expenditures, or those portions of other expenditures, that are directly related to such prosecution and that would not have been incurred if such prosecution had not occurred.
[3] The appellant was incorporated in 1991 by Mr. Paul Aumuller who had started the business in 1990. Broadly speaking, the business of the appellant is safety – environmental, occupational and public.
[4] The President, Mr. Aumuller, has had extensive experience in the fields of occupational health and safety and environmental safety. He has obtained a Bachelor of Environmental Studies from Waterloo University, has taken a two-year course in chemistry from Ryerson Polytechnical Institute of Technology and holds a Post Graduate Diploma in Industrial Hygiene from the University of Toronto. He has been employed in the industrial safety field since 1981, with Woodbridge Foam Corporation, Canada Metal Company and the Construction Safety Association of Ontario.
[5] The two projects with which we are concerned here have to do with waste urethane chemicals used in the manufacture of foam automotive seating.
[6] The waste generated by this industry was either left in barrels on the property of the manufacturer, such as the Woodbridge Foam Corporation, or sent to a landfill site or incinerated.
[7] Mr. Aumuller decided to develop a more economic and environmentally acceptable means of disposing of the waste chemicals, which fell into four categories:
- resin waste
- isocyanates
- solvent flushes
- oily water wastes.
[8] Two projects relating to the above wastes that are in issue here are:
(a) The Chemical Waste Dispositioning Alternatives ("CWDA") (1993 and 1994 taxation years);
(b) Solvent Flush Distillation Process (1994).
[9] So far as CWDA was concerned, the objective was to improve the disposition of waste chemicals of three companies that manufactured foam for automotive seats. It cannot, of course, be denied that a more economic and environmentally acceptable means of disposing of such materials than leaving them in drums or disposing of them in landfill sites is a desirable and commendable initiative.
[10] The first step was to determine the nature and quality of the waste. This necessitated an on site inspection of the drums and a sampling of the contents in each drum. 450 cc of waste were taken from each drum and tested in the appellant's laboratory. This testing was done by Mr. Aumuller. The only other person on the staff of the appellant was Mr. Accettone, a chemical engineer who had graduated in 1991 from the University of Toronto, and who had been hired by the appellant in 1993.
[11] The only detailed record that we have in evidence of the testing that was done is Mr. Aumuller's hand-written notes in tab 2 of exhibit A-1. The tests were as follows:
(a) a field test: adding 10 cc of the waste to 10 cc of MDI (diphenylmethane diisocyanate - a virgin isocyanate to determine the reaction;
(b) a bench test: 50 cc of waste and 30 cc of MDI. This test resulted in a bad reaction, essentially smoke;
(c) a 50/50 combination of waste and isocyanate;
(d) a compression test which involved putting a weight on the foam produced to determine its degree of resiliency;
(e) a blending test in which 50 cc of waste were blended with a virgin (unused) isocyanate.
[12] The objective of these tests was to determine the properties and composition of the contents of the barrels, with a view to classifying them in 7 different disposition categories:
1. "Supplier Return" – unopened barrels of virgin chemicals to be returned to the supplier.
2. "Work Away" – use of the contents in the manufacturing process.
3. "Secondary" or "Surplus" – the use in the manufacture of other products, such as under cushion carpet.
4. "Recyclable" – these were usually solvents used for flushing and cleaning equipment which could be separated from the waste mixture and reused.
5. "Incineration" or "Fuel Blended" – mostly resins, waxes and oils.
6. "In Situ and Stabilisation Treatment" – for small quantities of inorganic/laboratory chemicals: insignificant and not explained in the evidence.
7. "Landfill".
[13] The second project was the Solvent Flush Distillation Process, which involved the transportation of a sludge of solvent (usually methylene chloride or trichloroethane), resin and isocyanate. The solvent had been used to clean robotic heads that were used in the manufacture of foam, through the combination of resin and isocyanates.
[14] The objective was to separate the solvent from the resin and isocyanates so that the solvent could be used.
[15] The sludge would be picked up at the factory of one or other of the foam manufacturers and transported to Anachemia Ltée where it would be processed. Certain tests were performed to determine the composition and properties of the material, such as its viscosity and specific gravity following which it would be processed and the solvent returned to the manufacturers or, in the case of the residue, blended to form fuel and sold to cement kilns for its calorific content.
[16] Different methods were tried to separate the solvents from the sludge:
(a) a centrifuge;
(b) a spinning screen;
(c) bag liners that were resistant to high temperature.
[17] No method was particularly successful.
[18] In Northwest Hydraulic Consultants Ltd. v. R., [1998] 3 C.T.C. 2520, 98 DTC 1839, I set out a number of criteria that I found useful in determining whether a particular activity constituted SR & ED. They were as follows:
1. Is there a technological risk or uncertainty?
(a) Implicit in the term “technological risk or uncertainty” in this context is the requirement that it be a type of uncertainty that cannot be removed by routine engineering or standard procedures. I am not talking about the fact that whenever a problem is identified there may be some doubt concerning the way in which it will be solved. If the resolution of the problem is reasonably predictable using standard procedure or routine engineering there is no technological uncertainty as used in this context.
(b) What is “routine engineering”? It is this question, (as well as that relating to technological advancement) that appears to have divided the experts more than any other. Briefly it describes techniques, procedures and data that are generally accessible to competent professionals in the field.
2. Did the person claiming to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty? This involves a five stage process:
(a) the observation of the subject matter of the problem;
(b) the formulation of a clear objective;
(c) the identification and articulation of the technological uncertainty;
(d) the formulation of an hypothesis or hypotheses designed to reduce or eliminate the uncertainty;
(e) the methodical and systematic testing of the hypotheses.
It is important to recognize that although a technological uncertainty must be identified at the outset an integral part of SRED is the identification of new technological uncertainties as the research progresses and the use of the scientific method, including intuition, creativity and sometimes genius in uncovering, recognizing and resolving the new uncertainties.
3. Did the procedures adopted accord with established and objective principles of scientific method, characterized by trained and systematic observation, measurement and experiment, and the formulation, testing and modification of hypotheses?
(a) It is important to recognize that although the above methodology describes the essential aspects of SRED, intuitive creativity and even genius may play a crucial role in the process for the purposes of the definition of SRED. These elements must however operate within the total discipline of the scientific method.
(b) What may appear routine and obvious after the event may not have been before the work was undertaken. What distinguishes routine activity from the methods required by the definition of SRED in section 2900 of the Regulations is not solely the adherence to systematic routines, but the adoption of the entire scientific method described above, with a view to removing a technological uncertainty through the formulation and testing of innovative and untested hypotheses.
4. Did the process result in a technological advance, that is to say an advancement in the general understanding?
(a) By general I mean something that is known to, or, at all events, available to persons knowledgeable in the field. I am not referring to a piece of knowledge that may be known to someone somewhere. The scientific community is large, and publishes in many languages. A technological advance in Canada does not cease to be one merely because there is a theoretical possibility that a researcher in, say, China, may have made the same advance but his or her work is not generally known.
(b) The rejection after testing of an hypothesis is nonetheless an advance in that it eliminates one hitherto untested hypothesis. Much scientific research involves doing just that. The fact that the initial objective is not achieved invalidates neither the hypothesis formed nor the methods used. On the contrary it is possible that the very failure reinforces the measure of the technological uncertainty.
5. Although the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests and results be kept, and that it be kept as the work progresses.
[19] These criteria were referred to, without apparent disapproval, by the Federal Court of Appeal in RIS–Christie Ltd. v. The Queen, 99 DTC 5087. Both counsel accepted those criteria as appropriate in this case:
Was there a technological risk or uncertainty?
Dr. Blair, the expert called for the appellant, said that in his opinion there was "some uncertainty", I agree. There was uncertainty concerning the best method of disposition of the wastes. I do not, however, see on the evidence a type of uncertainty that cannot be removed by routine engineering or standard procedures. The testing of the contents of the barrels, recorded at tab 2 of exhibit A-1, was methodical and systematic. It was however something that a knowledgeable and competent chemist could do. The fact that the method of testing is routine is of course not fatal to a claim for SR & ED. However, the objective was not to test novel or untested hypotheses. It was to determine what was in the barrels.
With respect to paragraph 2 of the Northwest criteria. I am not sure just what technological uncertainty was identified or articulated, or what hypotheses were formulated to eliminate that uncertainty.
It may be assumed that the methods of testing in the appellant's laboratory was in accordance with established methods of scientific method, insofar as they were methodical and analytical. Nonetheless their objective was to determine the nature and composition of the drums of waste, with a view to disposing of it in a better way than taking it to a landfill.
Was there a technological advance? There appears to have been an environmental advance in that a significant reduction of materials going to a landfill occurred. This is not, however, a technological advance that could not have been achieved by routine engineering. I do not read Dr. Blair's report as identifying any new hypotheses that were tested or methods that were developed that could not have been tested or developed by routine experimentation.
The records are very scant indeed. We have Mr. Aumuller's notes at tab 2 of exhibit A-1, and nothing more. If any testing was done at the plant of Anachemia Ltée it is not apparent from the evidence. Tab 5 of exhibit A-1 is an analysis of the waste that was delivered to it for processing. This analysis does not constitute SR & ED.
[20] By far the largest part of the claims was for transporting the material to Anachemia Ltée, for processing and the cost of processing. There is simply no evidence of what portion, if any, of these costs were for testing or the nature of the tests, if any. It may be, as was held in RIS-Christie (supra) that written records in some cases are not necessary, but their absence in this case makes it impossible for me to determine whether any SR & ED went on at the Anachemia Ltée plant.
[21] While I tend to agree with the respondent's expert, Dr. Ritchie, that some of the work done on CWDA in 1993 may (I emphasize may) have met the definition of SR & ED, the evidence falls of establishing short, on a balance of probabilities, that the work done was SR & ED.
[22] So far as the Solvent Flush Distillation Process is concerned I am prepared to accept Dr. Ritchie's conclusions, which are as follows:
2. Solvent Flush Distillation Process (1994 Tax Year)
Objective
To develop an on-site system for recycling methylene chloride solvent flush material at a flexible foam manufacturer's facility.
Background
The solvent flush material is a sludge of solvent, resin and isocyanate in which there is some on-going slow polymerization (see solvent recovery part of 1993 tax year project 1). The flexible foam manufacturer had switched from trichloroethylene to methylene chloride in April 1993. About 70,000 L trichloroethylene and 5000 L methylene chloride solvent flush material had previously been distilled at Anachemia, with 80-90% returned as process solvent (1i).
Activities and Comments
Various filter systems were evaluated, but polymerization and hardening of the flush system caused filtration problems. This was routine development because the filter systems were commercially-available, filtration is well-understood technology, and the polymerization and hardening characteristics of the solvent flush material were known.
Sources of commercially-available solvent recovery systems and related equipment were reviewed, and a unit fabricator was selected. Tests provided data for unit design, and showed that a high-temperature liner bag prevented adhesion of distillation bottoms. Design and samples (distillate and still bottoms) were provided to the flexible foam manufacturer. This was standard practice engineering evaluation and design of commercially-available equipment in a mature and well-understood area of technology. Adapting known distillation technology and applications for on-site use at the source of the solvent flush material involved standard engineering practice with a high certainty of success.
Conclusions
The project is not SR & ED because it involved standard engineering practice and routine development, none of which resulted in technological advancements.
[23] While it is "possible" as was stated in a letter from the Department of National Revenue to the appellant's accountants, that there was "a core of eligible work embedded in project #1" (the CWDA), the evidence simply does not establish it.
[24] The appeals are dismissed with costs.
Signed at Ottawa, Canada, this 9th day of April 1999.
"D.G.H. Bowman"
J.T.C.C.