Docket: 2002-1991(IT)I

BETWEEN:

MARITIME-ONTARIO FREIGHT LINES LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Appeal heard on February 12 and 13, 2003, at Toronto, Ontario,

By: The Honourable Justice A.A. Sarchuk
Appearances:
Agent for the Appellant:	Doug Munro
Counsel for the Respondent:	Jenna Clark

____________________________________________________________________

JUDGMENT

          The appeal from the assessment of tax made under the Income Tax Act for the 1996 taxation year is dismissed.

Signed at Toronto, Ontario, this 24th day of September, 2003.

"A.A. Sarchuk"

Citation: 2003TCC674

Date: 20030924

Docket: 2002-1991(IT)I

BETWEEN:

MARITIME-ONTARIO FREIGHT LINES LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Sarchuk J.

[1]      This is an appeal by Maritime-Ontario Freight Lines Limited from a reassessment of its 1996 taxation year. In computing income for that year, the Appellant claimed Scientific Research and Experimental Development (SR & ED) expenditures and the related investment tax credit (ITC) in the amounts of $54,188 and $10,838, respectively. By Notice of Reassessment dated June 10, 1999, the Minister of National Revenue (the Minister) disallowed the Appellant's claim.

Facts

[2]      The Appellant is in the trucking business hauling general freight from Ontario and Quebec across Canada. In this business the Appellant and others charge their customers by the weight they ship. However, according to Doug Munro (Munro), the Appellant's president, a major problem exists in that many customers do not have scales and consequently, the declared weights on their bills of lading are often found to be inaccurate. It was therefore desirable to attempt to develop a device that among other things would correctly ascertain weight and thereby permit accurate billing of customers. In the late 1980s, a company, Alert-O-Brake Systems Inc. (Alert-O-Brake)[1], was established for the purpose of developing an electronic monitoring system for use in association with load handling vehicles such as, for example, forklift trucks. Munro was involved in the project as was Zeljko Ted Jurca (Jurca). In 1987, a patent was issued to Jurca with respect to such a device, the rights to which were subsequently assigned by him to Alert-O-Brake.[2] The Accu-Data system was marketed by Alert-O-Brake as early as 1990.

[3]      In or about 1994 the assets of Alert-O-Brake, primarily Accu-Data, were sold to the Appellant. It made further attempts to market the system but according to Munro sales were few because the customers would not accept the accuracy levels. Efforts were made to improve the weighing accuracy with the objective of developing a scale that could be sold to third parties as well as used in the Appellant's own business. Munro noted that to be "legal" for trade, the weight had to be accurate to 1/10 of 1% and that was their objective.[3] Difficulties were encountered and in 1995 the Appellant retained Jurca to provide the technical expertise and to do the development and necessary testing. Ultimately, it was unable to achieve its objective and in 1997 the project was discontinued.

[4]      Jurca, an engineer, completed courses at an electro-technical college in Zagreb, Croatia, and subsequently took industrial engineering courses in Toronto. He specializes in instrumentation design for vehicles such as cars, buses, trucks, helicopters, etc. and said that one particular area of his expertise was the development of "black boxes", i.e. small computing devices which, when hooked up to a host machine such as a truck or forklift, collect and record the desired information while the machine is in use. Accu-Data, the "black box" unit in respect of which the patent had been received, when connected to a typical-material-handling vehicle regardless of make or type analysed, in Jurca's words, "raw data from the forklift as far as the vehicle utilization, movements of the vehicle, lifting, driving, loaded, unloaded, lift and so forth, but the function -- one of the functions of the system was a weighing function as well". He added that this enabled management to obtain "automatic information for vehicle utilization, productivity, overloads, that type of thing. So the idea was to provide management information, that's about it, that utilization of the equipment".

[5]      Jurca's mandate when retained by the Appellant in 1995 was to "design and to come up with the weight measuring system that would be more accurate than we had prior to that year, basically, the improvement of the existing system". He said that Accu-Data when designed:

... had accuracy already, depending on the lift truck, that was the funny part of it. That's why it was so easy to do it. On some forklifts it was, let's assume, not a brand new vehicle but a really old used vehicle, I would get really good results, because everything was, what I call it - the hydraulic cylinder, chain, and everything else, everything was loose.

So, in other words, the way that my software was working, I would get pretty good results, believe me, 1%, but the problem was if I would take up - pick up that same load, let's assume, ten times - let's assume I was picking 1,000 pounds, sometimes I would get 1,010 pounds, sometimes 1,050 pounds. So if you take 1,000 pounds, 50 pounds, it's quite a big error, and that would happen, as I say, for whatever reason. I wasn't aware of what it was. Was it mechanical problems, was it software problems, was it design of the ... , that type of thing.

Thus, the objective project was

... to design the system to register 1% of applied loads. So, in other words, if I would pick up 1,000 pounds, 1% of the applied load would be 10 - 10 pounds. So that was my goal. ...

He went on to say that the technological uncertainties were both mechanical and software and that he intended to look at

... possibilities to improve my hardware on this side, maybe better amplifiers that are different technology or a change in the software as well, because the way you're catching those things, it's obviously a lot to do with the software as well. So it's a combination of all those three things, so that's what I was trying to do.

The methodology utilized by Jurca for this purpose essentially consisted of lifting known loads repeatedly with different makes of forklifts under different conditions in order to obtain data from the weighing function which could then be plotted and analysed. He said a number of modifications, both mechanical and computational, were made and their effects examined. One of the difficulties he faced was locating the source of discrepancies observed in the data reported by the weighing function of the "black box". He testified that attempts to weigh the same load often produced vastly different results and that the nature of these discrepancies could have been mechanical (i.e. that is due to the forklifts or computer hardware) or computational (i.e. due to the computer software). Ultimately, the result was

... that we got very close to 1% what I was trying to get to 1% of the lift/truck capacity, and I just didn't know anymore what to do next in order to get to 1% of the applied load type of thing, which I was trying to do. I felt, you know, that chance is that it's possible that something can be done in there, and more or less I don't know, I thought I was losing maybe.

As a result, it was conceded that it was unlikely the criteria of 1% of the applied load could be met and the project was abandoned.

[6]      The Respondent's position is based on a report prepared by Yashvant S. Parmar[4] and his testimony before this Court. His qualifications include a Bachelor of Science (Honours) degree (1974) in electrical and electronic engineering at the University of Leeds, Leeds, England. He has extensive experience in systems engineering in a number of areas including developing Requirements and Data Analysis, System Architecture design, Built-in Test design, System Test and Integration, Fault-tree Analysis, Failure Mode and Effect Analysis, Electrical Circuit Analysis, Software design and Analysis and Specifications (MIL-STD-490) ICDs. He has been employed by various technology companies since 1974 most recently as a senior system engineer by Spar Aerospace Limited and Honeywell Canada (1987 - 1995; 1995 - present). I should also note that Parmar has been a research and technology adviser to CCRA since September 2001.

[7]      It is also relevant to note at this point that the Appellant chose not to provide an independent expert's report and thus, Parmar's written report was based on one meeting with Jurca and his review of several documents which had been submitted by the Appellant to CCRA.[5] Included in that material was a "brief technical description of the Alert-o-Brake unit" captioned "Truck Check Weighing System" dated December 27, 2000 (author unknown) and a document referred to as a technical response with respect to the "SR & ED claim; Maritime Ontario Freight Lines Limited" dated August 17, 2001, prepared by Tino Sequeira. In this document, Sequeira made references to issues such as technological uncertainties, advancements and scientific and technical content to demonstrate the Appellant's conformity with the legislation. It was utilized by the Appellant's representative in his cross-examination of Parmar as though the positions expressed therein were unchallenged evidence. The fact is that there is nothing before the Court to establish that Sequeira was qualified in any manner to express an opinion. Furthermore, although he was in Court assisting Munro in some capacity, he was not called as a witness and thus, there is no evidence as to the source of the information contained in that document.

[8]      Parmar's opinion was that the work undertaken by the Appellant did not involve systematic investigation or experimental development intended to resolve the technological uncertainties, and resulting in technological advancements. He testified that on the basis of the material submitted and Jurca's testimony, it was difficult if not nearly impossible to determine whether there was a technological uncertainty. He said there could have been, however, the only evidence of uncertainty presented was the vague commitment on the part of the Appellant to improve the accuracy of the weighing function. This failure was compounded by a serious lack of documentation to establish what specific activity was undertaken to reduce or eliminate the factors identified by Jurca to have affected the accuracy of the device. He specifically referred to the failure by the Appellant to identify what technological barriers had to be overcome and stated that unless there was some evidence as to what these barriers were and what was done to deal with them, it was not possible to conclude that there existed a type of uncertainty that could not be resolved by routine engineering procedure. He further took issue with the Appellant's contention that the failure of the project itself was prima facie proof of technological uncertainty since there was such a paucity of documentary evidence or other material to establish the actual basis for the project's failure.

[9]      Reservations were also expressed by Parmar with respect to the development of hypotheses or any other plan in conjunction with the "scientific method" in order to confront the challenges faced. Although the Appellant listed a number of factors which could affect the weighing accuracy, none of the documents submitted indicated the formulation of any hypothesis. As well, Parmar also noted that none of the documents before the Court indicated that a procedure in accordance with established scientific methods was employed since no test data and/or analysis was presented for review and only general statements had been made. Parmar concluded that the result of the process was that no technological uncertainty had been established and thus no technological advancement had been made.

[10]     Although the Appellant introduced several photocopied pages from Jurca's logbook[6] as well as some copies of software changes and software diagrams[7] they provided little information to the Court. Parmar testified that in the normal course any scientist working on a complex problem keeps a logbook which will contain a substantial amount of information including technical data without which it is not possible to determine what was being done and what was the reason for doing it. The documentation presented consisting of three pages from Jurca's logbooks was of little value. According to Parmar "one of the pages indicated that they modified the three version (sic) of software, does not tell me what was the reason for modifications". He added that it was not clear from reviewing the documents what steps were being taken and what the reason was behind the changes made and spoke of being unable to see "what techniques they were trying to use to improve" the accuracy of the weighing function.

Analysis

[11]     For the purposes of subsection 37(1), the term "scientific research" is defined by Income Tax Regulation 2900 as follows:

(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,

(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

(d)         work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of the work described in paragraph (a), (b) or (c),

...

[12]     In C.W. Agencies Inc. v. The Queen,[8] Sexton J.A. observed:

            Both sides in front of us relied on the test outlined in Northwest Hydraulic Consultants Limited v. Her Majesty the Queen, 98 DTC 1839. In that case, Judge Bowman of the Tax Court outlined five criteria which are useful in determining whether a particular activity constitutes SR & ED. Those criteria have been approved by this Court in RIS-Christie v. Her Majesty the Queen, 99 DTC 5087 at page 5089. The criteria are as follows:

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

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

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

4.          Did the process result in a technological advancement?

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

[13]     Was there a technological risk or uncertainty?          On the evidence before me, I am not able to conclude that there was no technological risk or uncertainty in the Appellant's attempt at improving the weighing function of the "black box". However, there is a substantial question as to whether that uncertainty could be removed by routine engineering or standard procedures. In considering whether there was a technological uncertainty which was clearly identified by the Appellant, it must not be ignored that Accu-Data was a patented "electronic monitoring system for load handling" that in fact had a capacity of weighing the load. The issue insofar as the Appellant was concerned was that the performance of the system was not acceptable and, therefore, steps were taken to bring the weighing accuracy system within plus/minus 1% of the vehicle lift capacity. There is some merit in Parmar's comments that the manner in which the Appellant proceeded was akin to the use of "routine or standard engineering" practices in that efforts were undertaken to modify a pre-existing technological product.

[14]     Did the Appellant formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty:           A hypothesis is a tentative assumption or explanation to an unknown problem and, as a rule, this requirement is met by the existence of a logical plan devised to observe and resolve the hypothetical problem. Jurca, in a very general sense, did articulate certain matters affecting the desired objective as well as the experiments he carried out, which included both mechanical and computational problems. Although it was difficult to follow his testimony, it was apparent that the isolation of the various factors created problems as there were a number of unknown variables at any one time (control valves, hydraulic leakage, differences in the make of the lift truck, inadequate programming, etc.). There is, however, almost no documentary record of the steps taken by Jurca in this context. Parmar testified as to the necessity of having a plan and of analysis preceding design. Not the least of these is the formulation of a clear record intelligible to third parties which would allow them the opportunity of verifying the results independently. Parmar testified that neither the available documentary material or the testimony of Jurca provided him with sufficient cogent information to determine whether a hypothesis defining a clear objective and articulating the technological uncertainty had been formulated. After hearing Jurca's testimony, Parmar observed "it was difficult for me to understand what hypothesis was really made" and what steps were being proposed to eliminate the technological uncertainty if one existed. Parmar's reservations with respect to the absence of any clear hypotheses or other plans designed to confront the challenges faced by the Appellant are well founded.

[15]     Was a detailed record of the hypotheses tested and results kept as the work progressed:               It is fair to say that one of the main requisites of proper scientific experimentation is to produce recorded results which can be independently verified under identical conditions. An acceptable minimum is that the required level of documentation be one which illustrates the methods utilized and the results obtained so that these can be duplicated independently by a reasonable third party. There are virtually no documents before the Court which provide any comprehensible evidence of the nature of the experimentation carried out. Indeed, given the evidence of Jurca, no detailed records were kept and any that existed, such as the items presented in these proceedings, were intelligible only to Jurca but not to Parmar or to any other reasonable party. It is not surprising that the Appellant's objective, hypotheses and methods were unclear to the Respondent's scientific advisor and why the Appellant's theoretical results were not discernible from the practical ones.

[16]     The evidence before me fails to establish that the Appellant's project meets the criteria set out in the SR & ED regulations under Part XXIX of the Act. Accordingly, the appeal is dismissed.

Signed at Toronto, Ontario, this 24th day of September, 2003.

"A.A. Sarchuk"

CITATION:

2003TCC674

COURT FILE NO.:

2002-1991(IT)I

STYLE OF CAUSE:

Maritime-Ontario Freight Lines Limited and Her Majesty the Queen

PLACE OF HEARING

Toronto, Ontario

DATE OF HEARING

February 12 and 13, 2003

REASONS FOR JUDGMENT BY:

The Honourable Justice A.A. Sarchuk

DATE OF JUDGMENT

September 24, 2003

APPEARANCES:

Agent for the Appellant:

Doug Munro

Counsel for the Respondent:

Jenna Clark

COUNSEL OF RECORD:

For the Appellant:

Name:

N/A

Firm:

N/A

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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