November 16th, 2020
A recent decision in the AAT has affirmed a previous decision by Innovation and Science Australia (AusIndustry) finding that Activities registered under the R&D Tax Incentive were not in accordance with the legislative requirements.
Royal Wins Pty Ltd and Innovation and Science Australia  AATA 4320 (28 October 2020) was a dispute in respect of a registration in the FY16 and FY17 periods for development of an Integrated Hybrid Gaming Algorithm and Platform. The stated objective of the project was to “create a system based on a hybrid model game of skill and chance” and to “test and implement the individual standalone games, mathematical algorithms, global mechanical redistribution models and security features”.
This AAT decision is notably briefer than previous decisions on R&D Activities in recent years, and compliance proceedings appear to have been initiated by the ATO referring the registration to AusIndustry for an activity review in March 2018.
AusIndustry’s original compliance review concluded that the registered Core R&D Activities were not eligible as:
- “the Applicant had not demonstrated that the outcomes of the claimed R&D activities could not have been known or determined in advance on the basis of (then) current knowledge, information or experience. Specifically, the Respondent found that the claimed Core R&D Activities involved the application of existing knowledge and expertise, including through the use of standard software testing methods;
- the Applicant had not demonstrated that the claimed R&D Activities displayed a systematic progression of work that was based on the principles of established science, proceeding from hypothesis, to experiment, observation and evaluation, and leading to logical conclusions. Specifically, the Respondent found that:
- the solutions identified in the mathematical modelling undertaken by the Applicant were obtained by applying existing knowledge and using a “suite of standard testing”;
- the Applicant had not shown that the claimed Core R&D Activities involved the identification of a knowledge gap that required the application of a systematic progression of work;
- the Applicant had not demonstrated that the activities were driven by an hypothesis targeted to validate a specific technical or scientific proposition”.
The key issue considered by the AAT was whether Royal Wins Pty Ltd had conducted a core R&D Activity in accordance with the legislative criteria.
The AAT found that the activities registered in the FY16 or FY17 applications were not Core R&D activities for the purposes of the R&D tax incentive scheme. Key extracts from the decision include:
- “A threshold difficulty for the Applicant is the absence of documentation or records from which it can be determined what was done in each of the relevant years;
- I cannot be satisfied on the evidence what work was undertaken in performance of the claimed activities or when it was carried out. It is not just a matter of when activities were undertaken, but on the documentation available, I cannot be satisfied that the Applicant’s activities involved a systematic progression of work such as is required under the legislation;
- Although the applications state an hypothesis in relation to each claimed Core R&D Activity, those hypotheses are not recorded in any contemporaneous material. Moreover, I accept the Respondent’s submission that the hypotheses stated in the applications tend to be statements of objective (e.g. to “research and develop a dynamic algorithm which need to take into account the PRNG mathematics required to adjust to vary level of skill per player in the global ecosystem”);
- The hypothesis must be identified before conducting the experiment (although the hypothesis may be refined to take into account the results of the experiment). An ex-post facto attempt to construct or discover an “hypothesis” with the benefit of hindsight after the work has been carried out will not satisfy the statutory criteria;
- Documents include a number of short text documents with filenames including the words “hypothesis”, “experiments” and “conclusions”. These documents lack detail and appear to be ex-post facto reconstructions;
- I accept the Respondent’s submission there was no relevant contemporaneous documentation to establish that any relevant hypothesis had been developed or tested. To the extent that any hypotheses are identified, they are properly characterized as “vague, generalised descriptions” in the nature of a commercial objective as opposed to a proposition involving a degree of uncertainty that is formulated for the purpose of being either validated or invalidated by the conduct of an experiment”.
Key learnings from this AAT decision include:
- The need for a company to articulate a clear hypothesis at the outset of a project, which proposes the investigation of technical factors that will be tested during the experiments;
- The need to maintain documentation that aligns with the stated hypothesis. For example, if the stated hypothesis relates to testing whether a new algorithm can accurately process X level of data within X timeframe, documentation maintained should relate observations around the accuracy, speed and scale of data processed by the algorithm.
Whilst compliance activity of R&D Claims has become more reasonable over the past year since the Moreton Resources Case and new AusIndustry Compliance framework, this case again highlights the importance of documenting and assessing activities in accordance with programme regulator guidance.