Last week, the Full Federal Court (per Davies, Moshinsky and Steward JJ) handed down a decision in Moreton Resources Limited v Innovation and Science Australia  FCAFC 120. The outcome (subject to any appeal) could help resolve similar tax disputes under review or currently being appealed, particularly in circumstances where the disputes relate to R&D activities involving the application of existing technology at a new site.
The decision related to the interpretation of the “core R&D activities” concept in s 355-25(1) of the research and development (R&D) tax offset provisions, contained in Division 355 of the Income Tax Assessment Act 1997 (Cth) (ITAA97).
The Court allowed the applicant’s (Moreton Resources Limited (Moreton)) appeal from a decision of the Administrative Appeals Tribunal (the Tribunal) on the basis that the Tribunal had construed the words “experimental activities” in s 355-25(1) of the ITAA97 too narrowly, by concluding that activities that had a purpose of generating new knowledge with respect to the application of an existing technology at a new site were not “experimental activities” and therefore not “core R&D activities”.
The decision also reinforces that Innovation and Science Australia (ISA), the statutory body tasked with registering R&D activities of entities claiming the R&D tax offset, must consider the text, context and purpose of Division 355 when determining whether a taxpayer’s activities qualify as core or supporting R&D activities. The object of Division 355 is to encourage taxpayers to conduct R&D activities that might otherwise not be undertaken due to uncertainty around the return on investment in cases where the knowledge gained is likely to benefit the Australian economy. This object of the R&D tax concession must be taken into account when determining the scope of concepts like “core R&D activities” in the provisions.
Moreton commenced a pilot project to test the viability of using underground coal gasification (UCG) technology in Queensland. Its aim was to determine whether syngas produced from the application of the UCG process could, after processing, drive a gas turbine and that the process could be operated in an environmentally responsible manner.
Moreton undertook various activities in the 2012 – 2014 income years in relation to the project, including the necessary site remediation when the pilot gas facility broke down and caused underground water contamination. Moreton applied to ISA to register these activities as “core R&D activities” or “supporting R&D activities”. Once registered, Moreton would be entitled to tax offsets under Division 355 of the ITAA97 for certain expenses related to these activities.
ISA initially registered Moreton’s activities; however, following an investigation, revoked the registration after concluding that Moreton’s activities were not core or supporting R&D activities for the purposes of the ITAA97. ISA confirmed the decision on internal review and Moreton appealed that decision to the Tribunal.
In September 2018, the Tribunal affirmed ISA’s internal review decision, finding that many of Moreton’s activities were associated with complying with statutory requirements or standards (which are not core activities pursuant to s 355-25(2)(f) of the ITAA97).
Full Federal Court’s decision
Moreton appealed the Tribunal’s decision to the Full Federal Court on the basis that the Tribunal had erred in its construction of the definition of “core R&D activities” in s 355-25(1) of the ITAA97 and its application of that construction to the pilot project activities.
Moreton argued that the Tribunal was incorrect in finding that experimental activities whose outcome was unknown, would not qualify as “core R&D activities” if they related to the application of an existing technology for a specific site. It argued that the Tribunal was incorrect to focus only on the application of the UCG technology to activities in isolation when the legislation permits a set of related experiments to be considered in combination when being evaluated for the purposes of s 355-25(1). In these circumstances, Moreton’s activities, when viewed as a whole, ought to be seen as core R&D activities, and eligibility for the tax offset in respect of the activities undertaken should not be denied just because the activities were cut short due to the breakdown of the facility.
The term “core R&D activities” is defined in s 355-25. Relevant to this case is s 355-25(1) which states:
Core R&D activities are experimental activities:
(a) whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work that:
- is based on principles of established science; and
- proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
(b) that are conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services).
The Court concluded that the Tribunal had erred in its construction of the definition of “experimental activities” in the opening line of s 355-25(1). The Court noted that whilst both parties agreed that the words “experimental activities” should be given their ordinary meaning, the Tribunal had failed to adopt a construction that reflected the dictionary definitions. It concluded that the effect of the Tribunal’s construction “was that the word “experimental” in the opening line of s 355-25(1) narrowed the types of activities that could qualify as “core R&D activities” beyond the requirements of paragraphs (a) and (b)”.1
The Court held that, on the Tribunal’s construction, to determine whether activities are core R&D activities, it is necessary to consider whether the relevant activities are experimental activities. If they are not, then they cannot be core R&D activities. In the Court’s opinion, the words “experimental activities” in the opening line of s 355-25(1) have very little, if any, work to do beyond reflecting the type of activities described in paragraphs (a) and (b). The Court also concluded that s 355-25(1)(b) is capable of applying to activities having the purpose of generating new knowledge with respect to the application of existing technology at a new site.
The Court found that the Tribunal’s alternative construction of s 355-25 was not supported by the text, context or purpose of the provision. In that regard, the Court stated that the object of Division 355 of the ITAA97 “is to encourage industry to conduct research and development activities that might otherwise not be conducted because of an uncertain return from the activities, in cases where the knowledge gained is likely to benefit the wider Australian economy (s 355-5(1), set out above). The object is to be achieved by providing a tax incentive for industry to conduct, in a scientific way, experimental activities for the purpose of generating new knowledge or information “in either a general or applied form (including new knowledge in the form of new or improved materials, products, devices, processes or services)” (s 355-5(2)). At least in circumstances such as those of the present case, this object is capable of being served by activities that have the purpose of generating new knowledge with respect to the application of an existing technology at a new site”.
Before the Tribunal, Moreton had also submitted, alternatively, that if any part of the registered core R&D activities for the 2012 – 2014 years were not core R&D activities, then they were supporting R&D activities to core activities that ISA had previously registered in the 2010 year. This was on the basis that in order for activities to qualify as supporting R&D activities, they need to be undertaken for the dominant purpose of supporting core R&D activities.
However, the Tribunal had implicitly rejected Moreton’s alternative submission based on its findings in relation to the various pilot project activities as a whole, that “the pilot project did not meet the definition of “core R&D activities” because, in summary, it “was testing the application of existing technology at a particular site and nothing more””. If it had not made this finding, the Tribunal would have been required to examine the activities registered for the 2010 year to determine whether any of the 2012 – 2014 activities that do not qualify as core R&D activities, would in fact qualify as supporting activities. Accordingly, the Court remitted the matter to the Tribunal to undertake this factually intensive exercise.
Implications for taxpayers
The Full Federal Court’s decision in Moreton Resources confirms that it is wrong to adopt a very narrow interpretation of what constitutes core and supporting R&D activities as ISA did in determining that the application of existing technology at a new site could not qualify as a core R&D activity. Further, in interpreting the scope of the various concepts in Division 355, it is important to have regard to the text, context and purpose of the provisions.
For some taxpayers currently in dispute with ISA over R&D claims, the decision in Moreton Resources may operate as a circuit breaker to resolving the dispute, particularly in circumstances where the R&D activities in question relate to the application of existing technology at a new site.