R&D tax incentives: Customised basketball shoe not eligible – Tax Authorities

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In our
R&D tax incentives: Integrity rules and taxpayer alerts, we
explored the ATO’s Research and Development Tax Incentive
Program and provided guidance on tax transparency. In this article,
we take a look at a case study which explores the rigorous approach
to compliance of R&D tax regulators.

Case study: Active Sports Management Pty Ltd and
Industry Innovation and Science Australia [2023] AATA

The Administrative Appeals Tribunal (AAT)
decision of senior member Polak in
Active Sports Management Pty Ltd and Industry Innovation and
Science Australia was handed down on 6 December 2023. The
senior member was not satisfied the claimed activities involved a
systematic progression of work based on principles of established
science and which proceeded from hypothesis to experiment,
observation and evaluation, leading to logical conclusions.

Back in May 2019, AusIndustry determined that none of the
claimed activities relating to the development of a customised
basketball shoe were eligible R&D activities under the Industry
Research and Development Act 1986 (Cth). That decision was
confirmed by an internal review decision in November 2019 by
AusIndustry and was upheld by the AAT. Active Sports Management
(ASM) has appealed the decision of the AAT to the
Federal Court.

Relevant activities

ASM is an Australian company that imports and sells sports
apparel, footwear, accessories, hoodies and tracksuits. It also
designs and develops products with unique Australian features and
styles for the Australia market.

ASM lodged applications in both 2015–16 and 2016–17
for registration of two activities:

  • activity 1.1 – prototyping for tests and experiments

  • activity 1.2 – tests and experiments.

In 2016-17 it lodged an application for registration of activity
1.3 – other tests and experiments.

The senior member found there was a significant degree of
overlap between the claimed activities and how they are described
in the registration forms and considered all the activities

The claimed activities related to the development of a
customised basketball shoe, referred to as the “Delly1”,
to suit the personal requirements and playing style of Matthew
Dellavedova (Delly), an Australian professional
basketball player who played in the NBA. The activities involved
the manufacture of six prototypes by Quanzhou Peak Shoes Co Ltd
(Peak) in China ranging from a bespoke shoe to
modifications being made based on testing and feedback given by
Delly from training and camps.

ASM stated they were testing the prototypes to see if it would
meet Delly’s requirements and set out various aspects they
wanted to test to see if they could be done in relation to the
upper, flexibility, traction, heel counter and cushioning of the
shoe and whether the production versions performed in the same way
as the handmade prototype.

AAT decision

The tribunal found:

  • although specific data produced by the work undertaken could
    not have been known in advance, the activites were not ones in
    which an outcome could not have been known or determined in advance
    based on current knowledge, information and experience

  • it was unclear precisely what unknown outcome ASM was seeking
    to determine other than to create a basketball shoe which satisfied
    Delly’s specific requirements. The outcome was not directed to
    a technical or scientific uncertainty. It was a subjective outcome
    and one outside the control of ASM

  • it was unclear what modifications took place between the
    various prototypes and to what degree as the descriptions of
    modifications were general and vague

  • there was no evidence to establish that the outcomes of the
    specific modifications made to the prototypes could not have been
    known in advance

  • there was also no evidence about how Delly actually tested each
    prototype, other than that he wore each one either in training
    conditions or during play. The testing undertaken by Delly did not
    consist of repeatable, verifiable tests capable of isolating the
    effects of each of the design modifications actually being tested.
    His feedback was not technical in nature

  • there was no evidence given of the work undertaken by PEAK or
    whether it was attempting to formulate any scientific or technical
    hypothesis in relation to each prototype. The available evidence
    suggests PEAK was simply responding to instructions from Delly
    directly or via Mr Bickley, a director of ASM

  • the evidence also did not demonstrate how each
    ‘hypothesis’ was formulated and then tested on each
    iteration of prototype and how the outcomes were recorded and
    observed. Delly’s feedback on certain prototypes did not relate
    to the asserted hypothesis

  • sm Polak agreed with the evidence of Dr Sterzing, a scientist
    in the field of athletic footwear and R&D, that the hypotheses
    were actually objectives and description of what was done and were
    not hypothesis in the way that can postulate a certain fact to be

  • there was no evidence that the outcome of any of the asserted
    hypotheses was uncertain or unknown to the applicant or to a
    competent professional in the field. In fact, there was evidence
    that Mr Bickley was able to anticipate and predict whether certain
    features and modifications were not going to meet Delly’s

  • while there was some uncertainty around whether the
    modifications would satisfy Delly’s requirements, the
    uncertainty was not an unknown outcome in the context of developing
    a hypothesis

  • the nature of the testing done was not documented with any

  • the development of Delly 1’s design was likely through
    trial and error, as opposed to a scientific process

  • the evidence does not demonstrate that the knowledge sought by
    the claimed activities went beyond validating a simple progression
    from what was already known and went beyond merely implementing
    existing knowledge in a different context

  • the development and manufacture of the mesh upper was plainly
    undertaken by PEAK. There was no evidence to demonstrate that ASM
    was involved in the actual design or development of the upper mesh
    or that its development involved a systematic progression of work
    based on principles of established science nor formed part of the
    claimed activities, which consisted of the modification of
    previously known athletic shoe design features to meet Delly’s
    preferences or requirements.

  • None of the claimed activities were core R&D activities and
    therefore none were supporting activities.

The decision is being appealed to the Federal Court and we await
the outcome. It is a definitive decision and makes it clear that
the tribunal expects that there is not only a scientific and
systematic approach taken to R&D but that approach is recorded
in writing at the time. SM Polak stated:

“Contemporaneous written evidence detailing the process of
each activity will be highly persuasive because the recording of
such information is an indication that the activity was carried out
in a manner consistent with a systematic progression of

It is clear that contemporaneous written evidence is the best
evidence to confirm what has been done and why. However, it is
important to consider the 2020 Federal Court decision of

Commissioner of Taxation v Bogiatto [2020] FCA 1139, where
Thawley.J had to determine whether promoter penalties should be
imposed on the respondent in relation to tax exploitation schemes
that involved R&D claims.

As part of the decision, it was necessary for Thawley.J, in the
context of ATO expenditure, to determine whether a taxpayer had to
maintain relevant records. His honour accepted that a failure to
have such records might be a matter from which inferences might be
drawn including that certain activities did not take place or
certain expenditure was not incurred. He found however, at
paragraph 100, that the entitlement to the tax offset is not
dependent on keeping records to “substantiate that the claimed
R&D expenditure was incurred on R&D activities that have
been registered with AusIndustry”. He stated that entitlement
to the tax offset depends on whether the taxable facts are such
that the R&D claims were available. Whether those taxable facts
can be proved or established is a different issue. A taxpayer who
kept inadequate records but who was able to substantiate the
various matters required by the statutory scheme would still be
entitled to the tax offset. At paragraph 101 of the judgment he

“It is a misconception that documentary evidence is the
only kind of evidence which can substantiate the relevant taxable
facts. This might be done through witness statements, statutory
declarations or the giving of oral testimony. Such material might
or might not be supported by documentary evidence. The absence of
documentary evidence does not mean the testimony would have to be
rejected or was incapable of proving or establishing the relevant
asserted facts.”

While it is not the only available evidence to support what has
been done, written contemporaneous evidence is the best and
recommended form of evidence.

What can you do

We recommend companies adopt good governance, strictly document
evidence of a systematic progression of work based on principles of
established science and which proceeded from hypothesis to
experiment, observation and evaluation, leading to logical
conclusions and identify risks as early as possible.

This publication does not deal with every important topic or
change in law and is not intended to be relied upon as a substitute
for legal or other advice that may be relevant to the reader’s
specific circumstances. If you have found this publication of
interest and would like to know more or wish to obtain legal advice
relevant to your circumstances please contact one of the named
individuals listed.


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