R&D tax incentive - AAT case affirms the need for adequate R&D documentation

26 November 2020

In brief

On 30 October 2020, in a decision in Royal Wins Pty Ltd and Innovation and Science Australia [2020] AATA 4320, the Administrative Appeals Tribunal (AAT) determined that a taxpayer was unable to show that certain research and development (R&D) activities were core R&D activities for income tax purposes, as there was no relevant contemporaneous documentation to establish that any relevant hypothesis had been developed or tested.

The AAT affirmed the previous decision by Innovation and Science Australia (AusIndustry), finding the activities registered under the R&D tax incentive were not in accordance with the legislative requirements of the program.

This case highlights the importance of documenting activities in accordance with program regulator guidance.

In detail

This case was a dispute in respect of a registration in the 2015-16 and 2016-17 income years for the taxpayer’s activities related to the integration of gaming algorithms to develop a gaming platform. The AAT affirmed AusIndustry’s initial decision that the activities allegedly undertaken in the relevant years were not “core or supporting” R&D activities for the purposes of the Income Tax Assessment Act 1997 (Cth) (ITAA).

The stated objective of the taxpayer’s R&D 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”.

The AAT set out the requirement that a research hypothesis is a proposition to be tested by experiment. It is not merely a statement of the objective of a particular commercial project and 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.

The Tribunal found that to the extent that any hypotheses were identified, they were properly characterised 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.

It was acknowledged that industrial R&D would not necessarily follow the same path as that undertaken in a university setting - it is however an essential aspect of the systematic progression of R&D applications that there be adequate documentary evidence. What is required is documentary evidence of the application of a scientific method in a systematic progression of work from hypothesis to experiment, observation and evaluation, followed by logical conclusions.

The AAT stated that the documentation produced did not come near to satisfying the requirements, exhibiting a lack of structure, an absence of ordered recording of activities and results. The AAT was not satisfied on the evidence either what work was undertaken in performance of the claimed activities or when it was carried out. Accordingly, it was unable to establish if the activities involved a systematic progression of work as required under the legislation.

The takeaway

The AAT was not able to conclude what work was done or when it was done, whether the activities commenced with an hypothesis or if the activities were undertaken in a systematic progression of work based on the principles of established science. This resulted in a finding the registered activities were not core or supporting R&D activities for the purposes of the tax law.

All companies making R&D tax incentive claims should note the importance of keeping contemporaneous evidence and documenting activities in accordance with regulator guidance materials.

If you would like to discuss any of these matters further, or require assistance in regards to your R&D documentation, please reach out to your PwC R&D contact.