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PWK and ISA: AAT Finds in Favour of R&D Entity Over Disputed Activity Eligibility

A recent AAT case (PKWK and Innovation and Science Australia (Taxation) [2021] AATA 706 (24 March 2021)) has found in favour of the R&D entity in a dispute over eligibility.

The dispute related to a registration of activities for the financial year ended 30 June 2015 in respect of a registration for the following:

• Core Activity 1.1: Process design, modelling and mechanical design in respect of a soil treatment facility using pyrolysis technology;
• Supporting Activity 1.1.1: Project evaluation and documentation;
• Supporting Activity 1.1.2: Project management.

The ruling indicates that AusIndustry had originally refused to even register the R&D activities on the basis that:

• Activity 1.1 was not a core R & D activity for the purposes of the legislative criteria;
• Accordingly, activities 1.1.1 and 1.1.2 could not be supporting R & D activities

The R&D entity then sought an internal review of the refusal to register, which was affirmed on the basis that there was no core activity, since:

• “The Applicant had “not demonstrated that the outcomes of its experiments cannot be known or determined in advance on the basis of current knowledge, information or experience” and that the proposal only involved “optimising…… technology and processes [known to work] to account for different composition of municipal solid waste streams””;
• “The project activity relates to operational challenges that a qualified professional could overcome using their experience and knowledge in the field” and the Applicant “has not provided a detailed description of any experiments undertaken to address a scientific theory”;
• “The Applicant had “not demonstrated that the activity was conducted for the purpose of generating new knowledge…” and “the knowledge being sought does not go beyond validating existing processes and knowledge in its particular circumstances”.

The R&D entity then applied to the AAT to have the decision set aside.

The AAT’s primary issue in the matter, was to consider if the R&D entity had conducted an eligible core R&D activity in accordance with Subdivision 355-B.

Extracts of note from the ruling include the following:

• The fundamental elements of a hypothesis were identified in a consultancy agreement (and several other documents), which was noted as being a contemporaneous document by the AAT”;
• Errors in the work underlying R&D activities, whether fundamental or otherwise, does not necessarily mean that the work was not carried out in a manner consistent with a systematic progression of work based on established principles of science;
• The purpose of research and development activity can be established by viva voce evidence (orally in court);
• The process of looking at variables, making calculations, reworking the variables and inputs to achieve new calculations involving, to a significant level, trial and error for the purposes of achieving targeted optimal designs, does accord with the definition or concept of experimental in this context and within the meaning of section 355-1(a) the ITA Act;
• The Applicant contends, and the Tribunal agrees, that when one considers the language adopted in section 335-25(1) of the ITA Act, the outcome could not be known or determined in advance on the basis of the then current knowledge. The activities did lead to the generation of new knowledge in the design of the proposed treatment plant on a commercial scale. Indeed, Professor Haynes did concede that the facility designed by the Applicant is unlike any existing MSW pyrolysis facility,  and assuming it works, it would represent an improvement to existing or known processes for the treatment of MSW;
• In a commercial environment not every step will be recorded…This is understandable and an explanation that the Tribunal accepts;
• There was the modelling undertaken by PLPD which established that the additional energy required to condense the syngas and convert it into a saleable consistent fuel product was unworkable. The Tribunal considers that the definition of “new knowledge” in section 355-25(1)(b) of the ITA Act cast a sufficiently wide dragnet so as to capture new knowledge in the form of something that cannot be achieved as much as what can be;
• The correct and preferable decision is that the activities comprising Core Activity 1.1 were “core R & D activities” within the meaning of section 355-25 of the Income Tax Assessment Act 1997 conducted during the income year ended 30 June 2015.

The decision in this matter was a good result for the R&D Entity. However, as disputes over eligiblity and resorting to the AAT process is resource consuming, this decision serves as a timely reminder that:

• Hypotheses for core R&D activities should be clearly articulated and supported in contemporaneous documentation;
• During the registration process, a clear description should be provided to AusIndustry of how core R&D activities generate new knowledge;
• During the registration process, a clear description should be provided to AusIndustry of why the outcome of core R&D activities could not have been determiend in advance based on know.