January 15th, 2024
A new AAT decision handed down in December 2023 (Active Sports Management Pty Ltd and Industry Innovation and Science Australia) has found that activities in respect of development of a customised basketball shoe were not eligible under the R&D Tax Incentive.
Background points from the case include:
- Active Sports Management Pty Ltd, the applicant, carries out a business which includes importing and selling sports apparel, footwear, accessories, hoodies, and tracksuits, among other things. It also designs and develops products for the Australian market or with unique Australian features and styles;
- For the 2015-16 and 2016-17 years, Active Sports Management Pty Ltd registered activities under the R&D Tax Incentive related to the development of a customised basketball shoe, referred to as the “Delly1”, to suit the personal requirements and playing style of a famous Australian professional basketball player who at that time played in the NBA in America.
- Core R&D Activities included:
- ‘Prototyping for tests and experiments’;
- ‘Tests and experiments’, and
- ‘Other tests and experiments’.
- In 2019, Industry Innovation and Science Australia (IISA) determined that these activities were neither Core nor Supporting R&D Activities. The matter was then taken to the AAT.
- It was noted during the case that “There is a significant degree of overlap between the Claimed Activities, and how they are described in the registration forms. … Each refers to the process of developing prototype shoes and testing them to obtain feedback for the development of the Delly1.”
- Prototyping appeared to have involved the manufacture of each prototype by Quanzhou Peak Shoes Co, Ltd (PEAK) in China.
- Along with a statement from their director, Active Sports Management Pty Ltd submitted:
- A document noting the development history of the shoe, outlining six prototypes manufactured by PEAK;
- Photographs and videos of iterations, and
- Chat and email messages discussing the iterations.
- AusIndustry and AAT however found no evidence of the work undertaken by PEAK, and some inconsistency regarding the description of Prototype 1.
Points of note and extracts from the AAT ruling include:
- “In respect to the whole project, it is unclear precisely what unknown outcome the applicant was seeking to determine, other than to create a basketball shoe which satisfied the subject player’s specific requirements … I am not convinced that this is an outcome directed to a technical or scientific uncertainty. It is a subjective outcome and one outside of the control of the applicant.”
- “Considering the prototype specific outcomes, it is unclear on the evidence specifically what modifications took place between the various prototypes, and to what degree. The descriptions of the modification in the Development History are in very general and vague terms. Even so, the general outcomes could have been known in advance.”;
- “There is no documentary evidence of work undertaken by PEAK as part of the process to develop the Delly1 prototypes, other than the fact that it manufactured the prototypes. There is no evidence as to whether PEAK was attempting to formulate any scientific or technical hypotheses in relation to each Prototype. The available evidence suggests that PEAK was simply responding to instructions from the subject player’.
- Testing videos, while described as showing the subject player testing a prototype during a training session, were plainly taken for promotional purposes and was subsequently shared to Twitter to promote the Shoe. There is no evidence of the applicant actually using the video to evaluate the Prototype;
- “there is no evidence to establish that the outcomes of specific modifications made to the prototypes could not have been known in advance”
- No hypothesis was described, but several were asserted from the development history document provided during the case. To this, it was said:
- “There is no contemporaneous evidence that the applicant formulated these asserted hypotheses before carrying out either the manufacture of each prototype or the testing of each prototype. 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 evidence does not demonstrate how each hypothesis was tested on each iteration of prototype and how the outcomes were recorded and observed. It also appears on the evidence that feedback provided by the subject player on certain prototypes did not relate to the asserted hypothesis.”
- “There is no evidence about how the subject player tested each prototype, other than that he wore each prototype either in training conditions or during play. The testing undertaken by the subject player did not consist of repeatable, verifiable tests capable of isolating the effects of each of the design modifications actually being tested.”
- Thus, the AAT noted that it was, “not satisfied that the claimed activities involved a systematic progression of work based on principles of established science, and which proceeded from hypothesis to experiment, observation and evaluation, leading to logical conclusions”.
- Also, Active Sports Management Pty Ltd asserted that the addition of the mesh to the upper was new knowledge. However, evidence demonstrated that it was PEAK’s decision to use the mesh, and while it was a new process/product (i.e. new knowledge), there was no evidence to demonstrate that the applicant was involved in the actual design or development of the upper mesh. Thus, the AAT noted that it was, “not satisfied that the Claimed Activities were conducted for the purpose of generating new knowledge.”
It was found that, “none of the Claimed Activities were core R&D activities within the meaning of subsection 355-25(1) of the ITAA 1997. Rather, the Claimed Activities consisted of the modification of previously known athletic shoe design features to suit the personal preferences or requirements of an individual player.”
The case serves as a reminder of several points, notably:
- Core R&D Activities must have technical or scientific uncertainty, and companies should keep evidence to show the existing state of knowledge;
- There must be contemporaneous evidence showing that the hypothesis was created prior to experimentation, and there should be direct correlation between the hypothesised outcomes, testing and evaluation process, and conclusions drawn. Documentation and evidence submitted to support the application must also be for the purpose of testing the hypothesis, and not for another purposes, such as promotion;
- Experimentation must be based on established scientific principles, rather than akin to a ‘trial and error’ process.
- New knowledge must sought to be generated from the hypothesis, and must not be a mere application of existing knowledge.
Additionally, while this case looked solely at the eligibility of the activities, it’s also important to note that if any R&D activity was undertaken overseas, companies must lodge and attain an overseas finding approval.
This case again highlights the importance of documenting and assessing activities in accordance with programme regulator guidance so as to minimise the likelihood of ending up in dispute with the regulators.
Please get in touch with our office if you would like to speak to someone about a potential claim, or check out our website for more information.