SR&ED Legal Analysis – Life Choice Case

On January 31st, 2017, the Honourable Justice Patrick Boyle rendered a decision on Docket 2015-2308(IT)I
This case has to do with the development of natural health product formulations. Despite an abundance of reference material, some planning documents, new formulations that didn’t exist before, and solid technical testimony, CRA did not find that there was any evidence of “systematic investigation” because no testing had been performed.

From policy, we know that
“scientific research and experimental development means systematic investigation or research that is carried out in a field of science or technology by means of experiment or analysis”

In this case, it is clear that the claimant did not arrive at scientific advancement through experimentation but rather via analysis.

The claimant argued, that since there existed a scientific or medical uncertainty (which was not disputed by the Judge), and there existed new formulations as a result of the work done, one must make the logical conclusion that the advancement was obtained systematically via analysis. There can be no other rational conclusion.

The Judge’s ruling is then perplexing.

[50] It is the absolute absence of testing of the natural health products by Life
Choice after their formulations were hypothesized by Dr. Dahl that is fatal to this
appeal. It is a clear conclusion from the evidence that, not only was no such
testing done, neither Life Choice or Dr. Dahl ever intended to do any as part of
these Projects. The jurisprudence has clearly, consistently and correctly
interpreted the definition of SR&ED as requiring some form of testing of the
hypotheses developed in order for there to be systematic investigation or search
carried out by means of experiment or analysis.

[52] It is not the absence of clinical testing that is fatal to Life Choice’s appeal.
It is the absence of testing in any form or fashion that could be said to have been
performed in a systematic fashion. Systematic testing for any or improved
effectiveness of Life Choice’s formulations could have been done by Life Choice
and could have been performed to assess, verify, statistically infer, or gauge
effectiveness without full-blown clinical trials sufficient to satisfy Health Canada
if the products were restricted pharmaceutical products, which they were not.
Any such testing could have been performed in a manner that met the
requirements of the SR&ED definition even though it would not have satisfied a
Health Canada requirement, or if, as in this case, there was no Health Canada

The Judge refers to the Northwest Hydraulics case and RIS – Christie, which are Experimental Development cases, which almost always require tests and experimentation. Many Scientific Research cases do not involve any experimentation, as advancements in knowledge are achieved entirely through analysis.

In this case, the claimant most certainly did assess and verify effectiveness, however, he did so through complex literature studies, through thought processes, and through study of interactions of ingredients with each other and within the body. The claimant patently rejects the notion that there was no intention to test. Test protocols were designed, and quotes were obtained, and presented in court. But the firm was not in a position to pay for the testing. Furthermore, the Claimant did use the approved product formulations in its own clinical practice, with data collection and analysis, but not in the fiscal period in question.

The fact of the matter is that most Natural Health Product formulations in Canada are not physically tested. This represents an unfair burden for the Natural Health Product industry.

The Judge then states that the claimant didn’t have to conduct clinical trials in order to qualify, but could have engaged in some other forms of analytical testing that would have satisfied SR&ED. However, those types of testing were not requisite for the project, because, Health Canada does not require clinical trial testing for Natural Health Product Number approvals.

The Claimant argued that the NHPN application was a form of analytical test. The NNHPD (regulatory body) does not perform a clinical trial on every application, but approves or denies the application based upon its own analytical test. Apparently, this argument was not accepted or even addressed by the Judge.

The Claimant argued that analysis was conducted, however, mostly within the mind of the researcher. The iterations of the formulation changes were documented and presented as evidence.

The question then begs to be asked – what really is analysis? To the layperson, analysis is largely regarded as “thinking” or perhaps “sophisticated thinking”.

DEFINITION: Analysis: detailed examination of the elements or structure of something, typically as a basis for discussion or interpretation

Or in more detail, this definition

DEFINITION: noun, plural analyses
[uh-nal-uh-seez] (Show IPA)
1.the separating of any material or abstract entity into its constituent elements (opposed to synthesis).
2.this process as a method of studying the nature of something or of determining its essential features and their relations:
the grammatical analysis of a sentence.
3. a presentation, usually in writing, of the results of this process:
The paper published an analysis of the political situation.
4.a philosophical method of exhibiting complex concepts or propositions as compounds or functions of more basic ones.

5. Mathematics.
a. an investigation based on the properties of numbers.
b. the discussion of a problem by algebra, as opposed to geometry.
c. the branch of mathematics consisting of calculus and its higher developments.
d. a system of calculation, as combinatorial analysis or vector analysis.
e. a method of proving a proposition by assuming the result and working backward to something that is known to be true.
6. Chemistry.
a. intentionally produced decomposition or separation of materials into their ingredients or elements, as to find their kind or quantity.
b. the ascertainment of the kind or amount of one or more of the constituents of materials, whether obtained in separate form or not.

At no point in the Judgment does the discussion address the question of whether the Claimant actually performed the activity of analysis, albeit undocumented. The claimant verbally described activities that are highly aligned with the above definition. Were it not for analysis, how would it be possible to arrive at the new formulations without detailed study of the constituents and elements?

Then, does the question change from “did the claimant perform analysis” to “is there any evidence that the claimant performed analysis”? These are very different questions.

CRA routinely advises claimants to maintain naturally occurring records. This judgment seems to suggest that the claimant should have created superfluous documentation in order to demonstrate his thought processes to CRA, even though such evidence would not be necessary in order to conduct the analysis itself or arrive at the advancement in knowledge through the new formulations.

The Judge is also relying on a precedent that was derived from a case involving a highly sophisticated engineering firm that had the ability to maintain large volumes of technical records.

The Claimant in this case was practically a one-man-show. To require the same caliber of evidence as referenced in the Northwest Hydraulics case seems largely prejudicial and unfair to the Claimant.

The Judge says that the formulations cannot be considered an advancement in knowledge unless they are tested.

[49]The absence of any type of testing by Life Choice of the hypothesized
formulations also results in it remaining to this day unknown if any of Life
Choice’s formulations represented any form of advancement of scientific
knowledge whatsoever. It is not even known if there was any or no ability of the
originally formulated principal ingredients in Projects 2 and 3 to mimic the
existing pharmaceuticals, since Life Choice reformulated to use the existing
chemical pharmaceutical as soon as Health Canada allowed it to be used in a
licensed natural health product. Contrary to the Appellant’s position, a newly
hypothesized formulation cannot on its own be considered either knowledge or
the advancement of knowledge for these purposes.

Let’s explore this with a paradoxical case study.

The CRA reviewer assigned to this case volunteered his opinion that Albert Einstein’s famous theory of E=MC2 was not an advancement in knowledge, because it was not tested at the time (because it could not be tested with contemporaneous technology).

Around the same time, another CRA technical reviewer in another part of the country independently volunteered that the famous theory E=MC2 was the perfect example of an advancement of knowledge in the field of theoretical physics. There can be no doubt that the advancement was obtained through analysis, but not through experimentation

Here we can see an elaborate “analysis” of the rationale behind the famous equation.

So, the Life Choice judgment leaves us with many interesting questions.

  • If Analysis is a form of thinking, isn’t it fair to assume that it’s challenging to document?
  • Experimental Development cases clearly need to demonstrate experimentation, but do Scientific Research cases need to demonstrate physical experimentation?
  • How can it be that the Act requires the claimant to demonstrate an advancement through EITHER experimentation OR analysis, but according to this ruling, testing is always mandatory?
  • Can CRA dictate the types of analysis that are deemed eligible, when those types and methods of analysis are not clearly defined in the Act?
  • Can CRA mandate that companies (and especially small companies) be obliged to keep records of thought processes solely for the purpose of satisfying a CRA reviewer, when those records are not naturally occurring and not requisite for the scientific or technical project resident in the claim?
  • Why is it that one Tax Court Judge can accept the credible testimony of a witness as evidence of systematic investigation, but another judge requires written documentation that is not even intrinsic or naturally occurring for the project in question?

In conclusion, we find the following scenario very perplexing.

According to the Judge’s logic, the Hun MediPharma case was properly assessed even though the only activities were literature review and there were no clinical trials in that case. Somehow, the reversal of that denial was correct, because literature review without clinical trials can be deemed analysis (one must conclude), and apparently by the same logic, there is somehow a test in that case, because the Judge in the Life Choice case states in this judgment that testing is a mandatory activity, even though there was no testing in the Hun MediPharma Case, to which he refers as an accurate assessment of eligible work.

And then, the logic follows, that this claimant, Life Choice needed to demonstrate that testing was done (because it was deemed necessary in cases that involved Experimental Development RIS – Christie and Northwest Hydraulics, but not in the Hun MediPharma case), but clinical trials are not absolutely necessary (so states the Judge), but testing is always necessary, even when the Act clearly states that the advancement in knowledge must be achieved through “experimentation OR analysis”. So, we are to understand that we are looking for either experimentation OR analysis, but testing is always mandatory, but in this case it doesn’t have to be clinical trials, but the claimant could have performed some other form of analysis, even though those types of analysis don’t really represent tests.

This article was prepared by Julie Bond, President of Bond Consulting Group.

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