The Federal Court’s decision in Active Sports Management Pty Ltd v Industry Innovation and Science Australia ([2024] FCA 1346) provides critical guidance on the rigorous evidentiary and procedural standards required to qualify activities under Australia’s R&D Tax Incentive. This case highlights how courts interpret the legislative framework, particularly section 355-25 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), and underscores the importance of systematic experimentation, genuine technical uncertainty, and the generation of industry-wide knowledge.
This article explores the case in depth, analysing the key arguments, legal principles, and practical implications for businesses and professionals alike. You can find our other case studies here.
Background of the Case
Active Sports Management Pty Ltd sought to claim R&D tax offsets for the 2015–16 and 2016–17 financial years. The claims pertained to activities conducted during the development of the “Delly1,” a custom basketball shoe designed for NBA player Matthew Dellavedova. The company argued that the activities constituted core R&D under section 355-25(1) of the ITAA 1997, focusing on optimizing materials, durability, and athletic performance.
Industry Innovation and Science Australia (IISA) rejected the claims, finding that:
- The activities did not address significant technical or scientific uncertainty.
- There was no evidence of a systematic progression of work as required by the legislation.
- The work failed to generate new knowledge relevant to the broader athletic footwear industry.
The Administrative Appeals Tribunal (AAT) upheld IISA’s decision. Dissatisfied with this outcome, the taxpayer brought an appeal to the Federal Court.
Relevant Legislative Framework
Under section 355-25(1) of the ITAA 1997, core R&D activities must:
- Involve a systematic progression of work, proceeding from hypothesis to experiment, observation, and evaluation, leading to logical conclusions.
- Be undertaken for the purpose of generating new knowledge, including knowledge in the form of improved materials, products, processes, or services.
- Address significant technical or scientific uncertainty, which cannot be resolved by applying existing knowledge or standard practices.
Section 355-25(2) specifically excludes activities that:
- Relate solely to market research, product testing, or quality control.
- Adapt existing technologies or designs without resolving significant uncertainty.
- Focus on cosmetic or routine changes to products.
These provisions formed the basis of the Court’s analysis.
Key Legal Issues
The Federal Court examined whether the taxpayer’s activities satisfied the statutory requirements for core R&D under section 355-25. The case turned on three critical questions:
- Did the activities address significant technical or scientific uncertainty?
- Did the activities involve a systematic progression of work based on scientific principles?
- Did the activities generate new knowledge applicable to the broader industry?
Arguments by the Claimant
Active Sports Management advanced the following arguments:
- Addressing Technical Uncertainty:
The taxpayer argued that optimising materials, durability, and performance for high-intensity athletic use involved significant technical uncertainty. The company emphasized the unique demands of elite basketball players, which required tailored solutions.
- Systematic Progression of Work:
While admitting deficiencies in contemporaneous documentation, the taxpayer contended that the iterative testing of prototypes, material selection, and evaluation of performance metrics reflected a structured and methodical approach.
- Generation of New Knowledge:
The taxpayer claimed that the insights gained during the development of the “Delly1” advanced the understanding of high-performance athletic footwear and contributed to the broader industry.
- Errors in the AAT’s Evaluation:
The claimant argued that the AAT erred by placing disproportionate weight on the absence of contemporaneous documentation while undervaluing the expert testimony provided in support of the claim.
Arguments by IISA
IISA opposed the claim on the following grounds:
- Lack of Substantial Technical Uncertainty:
The modifications to the “Delly1” relied on established design principles and techniques. IISA argued that the activities aimed to adapt existing footwear designs rather than address a significant unresolved knowledge gap.
- No Evidence of Systematic Progression:
IISA highlighted the absence of documented hypotheses, experimental procedures, and evaluations. The iterative, trial-and-error approach described by the taxpayer did not satisfy the statutory requirement for a systematic progression of work.
- No Industry-Wide New Knowledge:
The outcomes of the activities were specific to a single athlete’s needs and lacked broader applicability to the athletic footwear industry. IISA pointed to section 355-25(2) exclusions, which rule out bespoke or cosmetic adaptations from qualifying as R&D.
The Federal Court’s Decision
Justice Goodman upheld the AAT’s decision, ruling in favor of IISA. The judgment focused on the taxpayer’s failure to meet the criteria under section 355-25(1):
1. Technical Uncertainty
The Court found that the activities involved incremental improvements based on established principles of footwear design. There was no evidence of significant technical uncertainty as defined in section 355-25(1)(c).
Justice Goodman referenced Federal Commissioner of Taxation v Montgomery (1999), emphasizing that technical uncertainty must involve unresolved questions that cannot be answered through routine engineering or design.
2. Systematic Progression of Work
The absence of contemporaneous documentation undermined the claim. Justice Goodman cited Docklands Science Park Pty Ltd v Innovation Australia, reiterating that systematic experimentation requires documented hypotheses, methodologies, and evaluations as stipulated in section 355-25(1)(a).
3. New Knowledge
The Court concluded that the work was confined to bespoke adaptations for a single athlete and did not advance knowledge applicable to the broader field of athletic footwear. Justice Goodman relied on Coal of Queensland v Innovation and Science Australia, which held that R&D must generate industry-relevant knowledge.
Key Takeaways
1. Documentation is Essential
Contemporaneous records are critical to substantiating claims. These must include:
- Hypotheses and objectives.
- Detailed experimental methodologies.
- Observations, evaluations, and conclusions.
Similarly, the importance of contextual evidence in tax disputes is underscored in Cheung v Commissioner of Taxation, which explores the distinction between income and gifts.
2. Address Genuine Technical Uncertainty
Activities must tackle significant, unresolved technical or scientific challenges. Routine refinements or adaptations of existing designs are unlikely to qualify.
3. Generate Industry-Wide Knowledge
R&D must produce knowledge that benefits the broader industry or economy, not just bespoke solutions.
4. Align Activities with Legislative Intent
Be mindful of exclusions under section 355-25(2), including routine testing, product adaptation, and quality control.
5. Seek Expert Guidance
Engaging legal and tax professionals early in the project lifecycle ensures compliance with statutory requirements and mitigates risk.
Conclusion
The Federal Court’s decision in Active Sports Management Pty Ltd v Industry Innovation and Science Australia demonstrates the rigorous evidentiary and procedural standards applied to R&D Tax Incentive claims. This case serves as a crucial reminder that businesses must document activities meticulously, address significant technical uncertainty, and generate knowledge that extends beyond bespoke solutions to benefit the broader industry.
For businesses looking to access the R&D Tax Concession, this judgment highlights the importance of aligning activities with both legislative intent and evidentiary expectations.
