Fresh Administrative Appeals Tribunal decision on R&D activities

A recent case decided by the Administrative Appeals Tribunal (AAT) in December 2023 (Active Sports Management Pty Ltd and Industry Innovation and Science Australia) has found the registered activities were neither eligible core or supporting R&D activities as defined by the Income Tax Assessment Act (ITAA)1997.

The activities involved creating customised basketball shoes for a professional basketball player and were found to not have been undertaken for the purpose of creating new knowledge, a systematic process of work, or resolving a technical uncertainty. The Tribunal upheld the decision of the Commissioner of Taxation to deny the claim in full.

Understanding the decision

The Applicant stated that the development of the customised basketball shoes took considerable time and there were many prototypes, revisions, and failures throughout the development process. In addition, it was noted the evidence provided by the Applicant included emails, WeChat messages, photographs and videos, as well as a document outlining the six different prototypes.

Important factors below were considered before reaching a conclusion:

• There was no evidence demonstrating a systematic progress of work being undertaken. Specifically, it was noted based on the documentation provided, the activity undertaken was more akin to a trial-and-error exercise rather than a repeatable, verifiable testing process capable of isolating the effects of each of the modifications.
• There was no evidence demonstrating the formulation of the hypotheses before undertaking the manufacturing or testing of the prototypes. It was noted that ‘the need for contemporaneous evidence of the formulation of a hypothesis is especially important, given it is the essential starting point of the activities and identifies the outcome sought to be achieved.’
• The supporting documentation provided did not provide evidence of the specific modifications made to the shoe or why the outcome associated with these modifications could not have been known or determined in advance by a competent professional. 

The AAT found the activities involved the modification of existing knowledge to suit the personal preferences or requirements of an individual and held none of the activities were core R&D activities as defined in the ITAA 1997.

Key takeaways

Case law can show applicants what evidence may be useful or not in deciding whether eligible R&D activities have occurred. Some of the main lessons from the case are:

• Evidence must be maintained to show that before undertaking the experiment the company developed a hypothesis, planned an experiment, which tested the hypothesis, and ultimately generated knowledge that did not previously exist in the public domain.
• Companies must delineate between core R&D activities and activities undertaken solely for BAU purposes, such as the creation of promotional materials related to the product.
• A ‘trial and error’ process alone generally does not meet the definition of a core R&D activity. It is important a planned experiment based on scientific principles has been followed and this can be evidenced. This may include evidence of the variables held constant (to enable the effects of specific modifications to be isolated and evaluated), the variables changed, and the variables measured or monitored in each trial.
• Core R&D activities must involve more than the application of existing knowledge applied to a different context. Particularly in scenarios where existing knowledge may be leveraged, companies must be able to evidence there was technical uncertainty, and a competent professional could not predict the outcome in advance of undertaking a planned systematic progression of work.
• Interestingly, while it was mentioned manufacturing and some of the testing was undertaken overseas, this was not discussed in detail as a part of the case. As flagged in the recently related taxpayer alert, activities undertaken overseas cannot be claimed without an Overseas Finding certificate that covers the activities. Where parts of an activity (e.g. manufacturing and testing) is undertaken overseas, companies also need to consider whether a complete Australian core R&D activity (proceeding from hypothesis, to experimentation, evaluation of results and the drawing of conclusions) was actually undertaken.

We are here to help

Case law is an important source of information for Grant Thornton’s Innovation Incentives team. Each case is considered and studied to determine the potential consequences for different stakeholders. Contact Grant Thornton’s R&D Tax experts below to find out how this case could be related to your claim.