Tribunal finds that eligible R&D activity needs to address unknown outcomes

On 24 January 2025, in the decision of Body by Michael Pty Ltd and Industry Innovation and Science Australia [2025] ARTA 44, the Administrative Review Tribunal (ART) 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 the combination of existing processes did not substantiate an unknown outcome.

The ART affirmed the previous decision by Innovation and Science Australia (IISA), finding that the activities registered under the R&D tax incentive were not in accordance with the legislative requirements of the program. The ART expressed their criticisms of the review process by IISA, limiting the eligibility of small businesses due to onerous documentation requirements not prescribed by the legislation.

The stated objective of the taxpayer’s R&D project under review in this case was to use six pillars (movement, nutrition, breathing, hydration, sleep and mindfulness) on an integrated basis to develop mental health treatment and assistance to users through a mobile application (app), ‘Body by Michael’. 

The ART examined a range of evidence, including the original registration application, IISA internal reviews, further documentary evidence filed at the tribunal and expert witness testimony. However, the taxpayer did not provide contemporaneous documentation regarding the metadata and algorithm for the app as it would be ‘hard to find’. 

As a statutory requirement to be a core R&D activity, the activity outcome could not be known in advance based on current knowledge, information or experience. The ART concluded this was not satisfied.

The taxpayer argued that integrating six pillars of health program was an unknown outcome, with no existing published research papers describing an integrated approach of the six pillars. The ART rejected this as too narrow, as the claimant was using known processes to obtain individual data (known as individualisation) through each pillar, and there was no other aspect of the activities which contained an unknown outcome. Expert witness evidence was provided that six pillars were equally effective, and an integrated program did not yield more successful results than an isolated one. The app and algorithm used known tools to measure variables, not new techniques or technologies.

Subsection 355-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) also requires that the outcome 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’, often referred to as ‘scientific method’. The ART found the taxpayer did not satisfy this test, because:

• in the absence of a hypothesis being formed at the outset (was formed in a later year), it could not be accepted that there was an experiment
• the taxpayer did not describe the experiment or establish the knowledge gap and the degree of uncertainty that an eligible experiment must seek to address
• little to no analysis was done to what led to the conclusions nor why they are logical; and
• hundreds of tests were undertaken and the ART was satisfied this was systematic work. However, the ART was not satisfied that the taxpayer had undertaken the required systematic progression of work from hypothesis to experiment, observation and evaluation, leading to logical conclusions.

The ART did note the activities were consistent with the principles of established science.

It was noted the taxpayer’s project demonstrated its reference to mental health as a field of medical science and was not a social science, therefore the R&D core activity exclusion in sub-section 355-25(2)(d) of the ITAA 1997 ‘research in social sciences, arts or humanities’, did not apply.

The ART criticised the IISA’s method for assessing the taxpayer’s claim, stating that the approach should consider the size and sophistication of the entity involved. The ART observed that, while there is no statutory requirement for contemporaneous documentation, the IISA’s expectations may inadvertently prevent small businesses from accessing the R&D tax offset. Although maintaining contemporaneous records is considered best practice and helps demonstrate R&D eligibility, it should not be a barrier for smaller entities.

The ART also noted that the IISA’s requirement for documentary evidence at the level expected in academia or research laboratories significantly restricts the accessibility of the R&D tax incentive, particularly for smaller firms. The ART emphasised that there is no mandated form of words for describing R&D activities; the key consideration is what activities were undertaken and whether they satisfy the eligibility criteria.

Additionally, the ART stated that the IISA should have provided clearer guidance to the taxpayer regarding the specific documentation required during the review process.

The ART also cautioned against using AI tools like ChatGPT for legal documents, as they may introduce errors and hallucinations.

All companies making R&D tax incentive claims should note the importance of identifying the unknown outcome at the outset of their experiments, in accordance with regulator guidance materials and retaining appropriate documentation to evidence. Taxpayers are urged to clearly describe the R&D activities undertaken in a way so they can be assessed whether they meet the statutory tests, including demonstrating activities were undertaken via a systematic progression of work from hypothesis through to conclusion. Taxpayers should be vigilant during a review ensuring only factually correct evidence is provided to support R&D eligibility and caution using unchecked output from AI tools.

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