Charmaine Chalmers, the National Leader of PwC’s R&D practice had the opportunity to interview Andrew Lewis1 of AusIndustry about the decision of the Administrative Appeals Tribunal (AAT) in Mount Owen Pty Limited and Innovation Australia [2013] AATA 573 (the Mount Owen case). Andrew is the Manager for AusIndustry’s R&D Tax Incentive Integrity Assurance section.

The Mount Owen decision is probably the most significant R&D case since the decision of the Federal Court in Industry Research and Development Board v Coal and Allied Operations Pty Limited [2000] FCA 979. The AAT found that none of the activities claimed by the applicant in relation to its open-cut coal mine at Mount Owen were R&D activities for the purposes of former s73B of the Income Tax Assessment Act 1936.

This interview provides some insights which will be of real interest to claimants into AusIndustry’s view of the implications of the case for future claims and how AusIndustry intends to review claims.

Charmaine: Despite the long history of the R&D Tax Incentive in various forms, we don't have a lot of case law - why did this case progress to the tribunal?

Andrew: In the main, AusIndustry makes positive decisions, which means the instances where AusIndustry disagrees with the claimant about eligibility actually represent a very small percentage of participants in the program.

This case had activities that appeared to be operational which Innovation Australia found were not  eligible, and proceeded to the Administrative Appeals Tribunal (AAT) because the company exercised its rights for a review of Innovation Australia’s decision. That is, AusIndustry doesn’t pursue companies in litigation – the company has appeal rights and in this instance the company exercised its right for a review by the AAT.

Charmaine: From AusIndustry's perspective, what do you consider the main precedential elements from the case?

Andrew: There were a number of them and AusIndustry published a summary in the R&D Tax Incentive bulletin in December 2013.

Where companies are carrying out (especially operational) activities there is a need to demonstrate that those activities are R&D activities – and for this you need a number of things. Some of the important elements are:

  1. Purpose of generating new knowledge – this does require evidence. It is –not sufficient to just assert this, particularly where production purposes exist.

  2. Specifics regarding what technical outcomes can’t be known without conducting experiments – the project being “complex” is not sufficient.

  3. Specific experiments that address those technical outcomes – it is not sufficient just to say the whole activity is an experiment.

On risk –whether the outcome can be determined in advance. It can’t be environmental or commercial risks around the project, it must be the outcome of specific technical experiments.

An important point from the case is the claimant’s need to be specific about the technical unknown they are experimenting to resolve. Claimants need to be able to substantiate this. This is not simply a question of documentation. There was a lot of evidence which the AAT viewed as general mining documentation. Therefore, if you are carrying on a mine (or any other production activity), where you are obviously carrying on activities for other purposes such as production, then it’s even more important to contemporaneously document the R&D activities.

Charmaine: What elements of the decision merely confirmed what AusIndustry believed was the correct interpretation and what elements established new precedent?

Andrew: In the main, the case confirmed AusIndustry’s positions. Other than that the AAT found additional activities ineligible2. And also, possibly the exclusions [dealt with in a later question]. In our view, the Guide to Interpretation is consistent with the guidance of the AAT in the Mount Owen case, but adapted to suit the new R&D Tax Incentive legislation.

Charmaine: What facts about the case limit its application? What can be applied broadly in reviews and what can't?

Andrew: I would encourage claimants not to look at the case and think what you can’t apply, but to look at what you can apply. Eligibility must be based on specific activities, with specific experiments. Documented hypotheses must be specific to the technical unknown. For example, “develop new process flow” is not specific enough. This means that claimants must keep documentation, and make sure that people know about it (eg management).

Charmaine: How is AusIndustry applying this case in review activity? Has this case changed the way reviews will be conducted? For all claimants? In mining specifically?

Andrew: AusIndustry applies legislation not cases. However, we do see that we can be more efficient and more effective, giving people certainty more quickly. Having this case to confirm our views, we can proceed with more confidence in our advice and decision making. We accept we’ve been taking longer than we’d like and not communicating clearly enough at times. We can be clearer on what information is required. This case has good lessons for all companies – we don’t see Mount Owen as being just a mining case, the issues are relevant to any industry.

Charmaine: What do you think this case says about the role of experts?

Andrew: The usefulness of experts in assisting with understanding eligibility depends what you want to use them for. Experts are useful within the area of their technical expertise – they are not usually experts in applying R&D Tax law. For example, what is state of the art, whether something can be resolved using existing knowledge, and whether something is routine are questions where an expert can help. The AAT did not accept some of the experts’ views but that’s because the facts appeared insufficient to support the expert’s opinion.

Charmaine: This is the first case on the application of excluded activities. This could be a concern for any highly regulated industry, from mining through to pharmaceuticals. What is AusIndustry's view on how broadly the exclusions, particularly the standards exclusion, should be applied?

Andrew: In general, AusIndustry attempts to apply a reasonable interpretation that gives an appropriate meaning to the words to achieve the policy intent. In the particular exclusion the AAT noted the wording “associated with” regulatory standards and thought it could be read broadly. I think these comments were not the main reasoning for the decision and the AAT didn’t go into lengthy discussion in its reasons. AusIndustry agrees that the exclusion is not completely narrow (it will exclude some activities) but   accepts that every activity is subject to a certain amount of regulation – things that are carried out for the purposes of regulatory compliance are likely to be caught, eg Environmental Impact Statements.

However, just because every mining activity needs to satisfy environmental law, we don’t think that  should exclude every mining activity. As a rule of thumb, AusIndustry is interested in the purpose of activity as indicative of whether it is excluded from being core. Is the activity being done to satisfy a regulatory requirement, or is it being done for an R&D purpose and incidentally subject to regulation?   But claimants do need to bear in mind that Innovation Australia and, where necessary, the AAT will make up their own minds on the facts. For a more detailed discussion of AusIndustry’s perspective on each of the exclusions people should refer to a Guide to Interpretation.

Charmaine: The Mount Owen case tells claimants about what wasn't adequate, but it doesn't tell us about what would have been adequate. How might Mount Owen have supported its R&D claims?

Andrew: I don’t wish to comment on the company, but rather what we can learn from the AAT decision. I’ll reiterate earlier general points – if you’re doing R&D, you have to have some evidence. This is broader than an R&D Tax Incentive compliance issue – undertaking R&D with no records is a waste of money and bad business practice. Create records that substantiate you’re doing R&D. Another important lesson  from Mount Owen is that if you are conducting the activities for another purpose then there is more reason to create documents which evidence the R&D. It may be the case that engineers make changes and there are no records of the activities, just a better design as an output – here is an example of where records do need to be kept, even emails. Contemporaneous records which allow the assessors, after the fact, to understand the experimental process. You might not have a formalised hypothesis, but you do need to be able explain what technical “thing” you were testing.

The legislation defines a limited set of activities which the Incentive is available for – the whole commercial project is unlikely to be eligible – you need to assess what components of the project meet the requirements. In Mount Owen, the applicant didn’t demonstrate any experiments, innovation or high levels of technical risk and the AAT could not see how they had applied the law when developing their registration and claiming.

Charmaine: What do you think the future of mining claims looks like? What advice can you give to claimants?

Andrew: There have been problems with claims to a substantial amount of business as usual mining, often representing much of the cost of developing a mine – Mount Owen is one of these – where a substantial amount of mining activities were claimed. This is not limited to such claims – AusIndustry sees these issues in various other fields. The law has changed to require the specific core and supporting activities to be identified, and dominant purpose applies for supporting production activities. There is an obligation to self-assess and apply the legislation – this means identifying specific experiments that address the specific technical issues, then identifying what is supporting to those. It is necessary to build  it from the detail up – not start at the project and work down. There is a lot of R&D going on (including in mining) – the problem arises when people don’t sufficiently identify the R&D with enough specificity.