Court Case Clarifies SR&ED Eligibility Criteria for IT Development Projects

The Tax Court of Canada has further clarified SR&ED eligibility for information technology (IT) development projects by expanding the interpretation of “technological uncertainty” in the Scientific Research and Experimental Development (SR&ED) program with its ruling in DAZZM Inc. v. His Majesty the King (2024 CCI 129).

Although not precedent-setting because of the informal nature of the hearing, this decision carries significant implications for how SR&ED claims, particularly in the IT sector, are assessed and validated by the Canada Revenue Agency (CRA).

Background: Partial Denial of SR&ED Claims

DAZZM Inc. (“the Appellant”) appealed the CRA’s partial denial of its 2018 SR&ED claim. The Minister of National Revenue (“the Minister”) had initially disallowed one of the two claimed projects, stating that it failed to meet the requirements under subsection 248(1) of the Income Tax Act.

The disputed portion concerned Sub-project 1 of a broader SR&ED initiative. While the CRA accepted that Sub-projects 2 through 4 qualified with $61,314 in eligible expenditures, it denied the $208,853 claimed for Sub-project 1. The Minister’s position was that this work did not involve a technological uncertainty.

However, Justice Gagnon disagreed, ruling that Sub-project 1 did in fact involve technological uncertainty and that the full $270,167 in claimed expenditures was eligible for SR&ED.

Sub-Project 1: Addressing System-Level Software Performance Barriers

Sub-project 1 focused on the development of a software platform for corporate IT departments aimed at enabling remote program hosting and supporting multi-user access.

The project involved integrating four key tools—React, Redux, Styled Components, and Higher-Order Components (HOCs)—into a cohesive system. While each of these tools was known, their combination resulted in unacceptable data processing inefficiencies. Despite consulting publicly available resources and implementing several iterations of code refinements, the performance issues persisted.

The Appellant’s development team ultimately discovered that the performance bottlenecks arose from the combined use of these tools—especially the overhead from HOCs and standard Redux connection points—and began testing unconventional strategies to resolve the inefficiencies.

Determining SR&ED Eligibility Using the Five Questions

Justice Gagnon applied the established Northwest Hydraulic Consultants Ltd. v. The Queen (98 DTC 1839) framework to assess whether the Appellant’s work qualified as SR&ED. This approach centres on five key questions used to identify the presence of scientific or technological uncertainty:

1. Was there a technological risk or uncertainty that could not be eliminated by standard procedures or routine engineering?
2. Did the claimant formulate hypotheses specifically aimed at reducing or eliminating that uncertainty?
3. Did the procedures adopted align with the scientific method, including formulation, testing, and modification of hypotheses?
4. Did the process result in a technological advancement?
5. Was a detailed record of hypotheses tested and results maintained?

Court Findings

1. Technological Uncertainty at the System Level

Justice Gagnon emphasized that technological uncertainty should be evaluated at the project level rather than at the task level. The Court found that while each of the tools used was known, their combined performance limitations created an unpredictable system behaviour that could not be resolved using standard approaches.

This type of “system uncertainty” has been recognized as legitimate technological uncertainty in other SR&ED cases. Learn more in our blog on How to Qualify for SR&ED.

2. Hypothesis Development to Resolve Uncertainty

The Appellant structured its work around clear, testable assumptions aimed at resolving the performance issues. The judge concluded that these assumptions were legitimate and remained unchallenged by the Minister.

3. Application of the Scientific Method

Evidence demonstrated that the Appellant’s approach of iteratively testing, measuring, and modifying their code was aligned with the scientific method. Known public solutions were tested and rejected, and custom strategies were explored in a methodical manner.

4. Technological Advancement Through Negative Results

Although the Appellant did not achieve full resolution of the performance issue, the systematic rejection of multiple hypotheses demonstrated that the problem remained unresolved and complex. In line with Northwest Hydraulic, this reinforced the presence of technological uncertainty.

5. Documentation and Recordkeeping

While contemporaneous timesheets were not provided, the Judge accepted alternate documentation, including time estimates and performance metrics, as sufficient. The Appellant presented a detailed account of the project timeline, development stages, and measured outcomes.

Key Implications for IT SR&ED Claimants

The DAZZM Inc. decision provides valuable clarity on SR&ED eligibility, particularly for software development and IT systems integration projects. Notable takeaways include:

• Project-level analysis is critical: Eligibility must consider the overall project context rather than isolated tasks.
• System-level uncertainty is valid: Combining known components can create unpredictable interactions that qualify as technological uncertainty.
• The “five questions” remain relevant: Despite the CRA’s introduction of the “How and Why” assessment framework in 2021, the court continues to apply the Northwest Hydraulic criteria.
• Contemporaneous records help—but aren’t always required: Provided that the work is documented clearly and supported by reasonable methodologies, the absence of real-time timesheets may not be fatal to a claim.

Stay Informed on SR&ED Eligibility

The SR&ED program continues to evolve through court decisions that clarify key legal and scientific concepts such as technological uncertainty. Ryan’s team of funding experts closely monitors these developments and helps businesses navigate the complex SR&ED application process.

If your organization is making investments into your internal IT systems or software development that have encountered technical challenges, speak with a member of our Canadian Government Funding team to assess your project’s eligibility under the SR&ED tax credit program.

Learn more about Canada’s largest funding program for businesses. Claim your copy of the SR&ED 101 guide to learn more about how your business can receive up to 69% of labour costs towards internal R&D projects, along with other eligible expenses.