Taxpayer wins in latest AAT R&D decision

Articles Written by Kathryn Bertram (Partner)

The Administrative Appeals Tribunal (AAT) recently held in favour of taxpayer PKWK in a research and development (R&D) dispute against Innovation and Science Australia (ISA).

This case concerned PKWK’s entitlement to register certain R&D activities as core R&D activities (as defined in s 355-25 of the Income Tax Assessment Act 1997 (Cth) (ITAA97)) or supporting R&D activities (as defined in s 355-30 of the ITAA97) with ISA.

The case was heard by Senior Member Cameron, who delivered a thorough judgment, which includes some interesting commentary that taxpayers involved in R&D cases should be aware of including:

a) the importance of ensuring experts are appropriately briefed, do not assume the role of an advocate and identify errors as soon as they become aware of them;

b) that allegations against a party ought to be raised at the earliest opportunity;

c) a taxpayer’s documentation will not always be as detailed as is desirable;

d) errors in work performed don’t necessarily mean there was no systematic progression of work;

e) a hypothesis can be demonstrated through oral evidence; and

f) the generation of new knowledge is capable of coexisting with other purposes.


Mr A (who is the sole director of PKWK) established a business to remediate contaminated soil. In April 2015, PKWK completed construction and commissioned a soil treatment facility. In 2014, during the later stages of construction of the soil treatment plant, PKWK undertook certain activities to determine whether pyrolysis technology (which involves decomposing organic material by heating it in the substantial absence of air) could be applied to the processing of municipal solid waste (MSW).

PKWK sought to register these activities as core or supporting R&D activities. Registration of the activities was essential to enable PKWK to access the R&D tax incentive. As part of this project, PKWK signed a consultancy agreement with PLPD (a company established by Mr A’s father) dated 15 August 2014. ISA determined that the activities sought to be registered were not core or supporting R&D activities. This decision was confirmed by internal review at ISA. As a result of this, PKWK sought review of the internal review decision in the AAT.

Mr James Bland (a chemical engineer) gave expert evidence on behalf of PKWK and Professor Brian Haynes gave expert evidence on behalf of ISA. Mr A, Mr Morey (an engineer employed by Lycopodium, a separate entity that was engaged by PKWK to work on the MSW project) and Mr G (a project manager involved in developing and designing the MSW treatment facility for PKWK) were lay witnesses.

We outline below some key learnings for taxpayers that are highlighted by this decision.

Ensure experts are appropriately briefed

It is critical to appropriately brief experts so that the reports they prepare assist the ultimate decision maker. The AAT found that a joint report prepared by Mr Bland and Professor Haynes had “limited utility” because the question they were asked to address was not the correct question as posed by the statute. The question posed by the brief was whether the activities could “reasonably be expected” to generate new knowledge, whereas s 355-25(1)(b) of the ITAA97 asks whether the R&D entity (here PKWK) had the necessary purpose of generating new knowledge. 

The AAT also noted that no letter of instruction was given to Professor Haynes prior to him preparing his second report. Such instructions may have assisted him to apply the tests set out in the legislation rather than developing his own test. For example, the AAT noted that Professor Haynes concluded there was no new knowledge (an element of the criteria in s 355-25(1)(b) of the ITAA97) gained by PKWK because there was no “fundamental uncertainty” about individual processes nor about the general manner of their interconnection in pyrolysis of MSW that could be addressed by process simulation alone. However, as the AAT noted, “Professor Haynes use of the term “fundamental uncertainty”, or for that matter something unexpected and/or surprising, does not accord with any proper construction of the text of section 355-25” of the ITAA97. It also stated that “the experimental activities identified in this section are those whose outcome cannot be known or determined in advance. It is a different concept to a fundamental uncertainty or something unexpected and/or surprising… [which] requires a higher threshold for an applicant to satisfy. It is not what the section of the [ITAA97] requires.

The AAT observed that the letter of instruction to Professor Haynes dated 25 July 2017 (sent prior to his first report) did not a use the words “fundamental uncertainty”, “novel”, “unexpected” or “surprising”.

Experts should not assume the role of advocate

The AAT noted that Professor Haynes had observed that PKWK had no patent protection for its tube layout and that this would have been evidence of novelty and innovation in design. The AAT acknowledged that it did not appear that Professor Haynes was ever instructed to express an opinion on this topic and did not have the relevant expertise to warrant such discussion. The AAT concluded that “contrary to his obligations as a responsible expert as required by the Tribunal’s Persons Giving Expert and Opinion Evidence Guideline 2015, he assumed the role of, or very close to, an advocate for the party who engaged him, namely [ISA]. He certainly stepped beyond what he was asked to do when, in his second report, he addressed the issue of the lack of patent protection by [PKWK] for the tube layout.”

The AAT found this did not assist it and stated that this was a reason to prefer the opinion expressed by Mr Bland.

Experts need to identify errors as soon as they become aware of them

Professor Haynes made two errors in his reports. However, despite adopting his reports as true and correct when he gave oral evidence at the hearing, the errors were not corrected by Professor Haynes until he was cross-examined by PKWK’s counsel. The AAT concluded this did not assist it because “[e]ven if one were to give Professor Haynes the benefit of the doubt in relation to the two errors identified, it seems inconceivable that these matters were not clarified when he adopted his report at the commencement of his evidence and stated that he believed the opinions expressed in it to be accurate. Overall, his approach to these errors do not reflect well on him as an expert witness.”

Not only is this misleading, not identifying the errors affects the expert’s credibility and may contribute to the AAT not accepting the expert’s evidence. Clients pay experts to prepare evidence to assist the AAT and don’t want to have those reports disregarded because the expert is not candid in identifying a known mistake.

Allegations against a party ought to be raised at the earliest opportunity

The AAT noted that ISA had suggested that a diagram prepared by PKWK had been modified to appear as if the work had been performed in 2015, when in fact it was performed in 2013. Whilst specifically stating that she did not allege fraud, in closing oral submissions ISA’s counsel argued that the alleged modification was misleading and went to the question of the reliability of Mr A’s evidence. The AAT acknowledged the seriousness of the allegations and found it strange that the allegations were not raised prior to the hearing (such as in ISA’s Statement of Facts, Issues and Contentions). The AAT concluded that “[o]ne would have expected them to have seen the light of day in such a document, or even if one gives [ISA] the benefit of the doubt, a reasonable time before the hearing of this application so that [PKWK] had ample opportunity to address such allegations. It is surprising that this did not occur.

During his cross-examination, Mr A disagreed with the proposition that the document was prepared in 2013. He identified differences between the documents from July 2013 and those in 2015 and had contemporaneous documents to support his position. The AAT accepted that the documents were prepared in the relevant income year.

Documentation will not always be as detailed as is desired

PKWK was unable to identify various iterations of calculations and modelling referred to by Mr Morey in his statements. The AAT noted that Mr Morey had observed that these documents “are not generally of interest to clients and not always retained…during the design phase, the company does not keep revisions of every single change made. Principally clients are concerned with the outcome.” The AAT accepted this answer and noted that this was understandable because “at times best engineering practices, such as six decimal place accuracy, will not always be achieved in commercial environments.” This shows that a taxpayer does not have to show every version of a document in order to prove that the work was conducted or that it was systematic.

Errors in work performed don’t necessarily mean there was no systematic progression of work

The AAT observed that ISA had argued that there were fundamental errors in the work performed by PKWK. However, the AAT preferred the assessment of Mr Bland and found that “[t]he fact that there are errors in the work product, however they may be described, 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. There may well be errors made for a variety of reasons, but it does not exclude the possibility nonetheless of the conclusion being reached, as has occurred in this matter.”

The AAT also referred to the evidence of Mr Morey and observed that he “readily acknowledged the errors concerned and candidly stated that they represented work that still needed to be resolved.” The AAT was prepared to accept this evidence and noted it was understandable, stating that “[t]his evidence concerning errors must be viewed with the realities of developing a project of this magnitude in mind.” Again, this is helpful because it shows that whilst errors are not desirable, taxpayers are not prevented from relying on work product that contains some errors which can be explained in the context of the project.

Hypothesis can be proven by oral evidence

ISA argued that PKWK had not identified a contemporaneous record of a hypothesis. The AAT accepted that “the purpose of such research and development activity can be established by viva voce evidence”. In this regard, the AAT accepted the evidence of Mr A and Mr G concerning the formulation of the hypothesis and recording of the hypothesis in the PLPD consultancy agreement.

New knowledge capable of coexisting with other purposes

In relation to the requirement to generate new knowledge in s 355-25(1)(b) of the ITAA97, the AAT found that this purpose is capable of coexisting with other purposes. It stated that “[i]nsofar as [PKWK] had a purpose of carrying out the activities to develop and construct a new commercial scale plant processing MSW, it can coexist, and almost certainly will as a matter of course, with the purpose of producing electricity, fuel and char in accordance with the hypothesis developed.”

It also held that “the definition of “new knowledge” in section 355-25(1)(b) of the [ITAA97] 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 outcome of the modelling undertaken by PLPD, as described by Mr A in his evidence, must be new knowledge in the relevant sense as it resolves the question of what can and cannot be done when attempts are made to process syngas in this way.”

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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