The AAT has found that an Australian-based company in an international pharmaceutical research group conducted a core R&D activity when it ran a clinical trial to determine the safety and efficacy of a client’s drug.
Innovation Australia refused make an advance finding that the taxpayer’s clinical trial was a core R&D activity after finding that the only significant purpose of the trial was to perform specific services for the client. The AAT disagreed, finding that the trial satisfied the definition of “core R&D activity” in s 355-25(1) of the ITAA 1997 because it was an experimental activity and one of its substantial purposes was to generate new knowledge. The Tribunal rejected Innovation Australia’s submission that the purpose of generating new knowledge must be the dominant or prevailing purpose. In the Tribunal’s view, the relevant purpose “must be more than an insubstantial purpose; it must be substantial enough to enable the activity to be accurately characterised as conducted for that purpose”.
The Tribunal also rejected Innovation Australia’s submission that there was little practical point in making an advance finding because the taxpayer could not satisfy the operative provisions of Div 355 of the ITAA 1997. The fact that the taxpayer would not be entitled to the R&D tax offset (because its activities did not meet the conditions set out in s 355-20) was irrelevant in determining whether the definition of “core R&D activity” was satisfied, the AAT said.
(Re JLSP and Innovation Australia  AATA 23, AAT, File No 2014/5955, Frost DP, 22 January 2016.)
[LTN 15, 25/1/16]
Tax Vine Report
The AAT has found that an Australian-based biopharmaceutical company in an international corporate group conducted a core R&D activity within the meaning of s 355-25(1) of the Income Tax Assessment Act 1997 when it conducted clinical trials to determine the safety and efficacy of a drug.
As such, notional deductions and tax offsets may be available to the applicant for the 2013-15 income years.
The question before the AAT was whether the applicant’s activity was conducted for the purpose of generating new knowledge. Innovation Australia refused to make an advance finding that the taxpayer’s clinical trial was a core R&D activity. It said that the only significant purpose of the trial was to perform specific services to fulfil their contractual obligations.
The AAT rejected Innovation Australia’s submission on the basis that the trial satisfied the definition of “core R&D activity” in s 355-25(1) because it was an experimental activity for the purpose of discovering something unknown or testing a principle and that the outcome of the activity could not be determined in advance. The AAT also rejected the argument that the purpose of generating new knowledge must be the dominant or prevailing purpose. Instead, the AAT considered that the “purpose of generating new knowledge must be more than an insubstantial purpose and must be substantial enough to enable the activity to be accurately characterised as conducted for that purpose.”
Catchwords  AATA 23
INDUSTRY RESEARCH AND DEVELOPMENT – whether activity is core R&D activity – clinical trials carried out to determine safety and efficacy of a drug – definition of ‘core R&D activity’ – whether activity conducted for the purpose of generating new knowledge –purpose must be held by applicant R&D entity – purpose of generating new knowledge not required to be the dominant purpose but must be more than an insubstantial purpose – Tribunal finds that Activity 1 is a ‘core R&D activity’
INDUSTRY RESEARCH AND DEVELOPMENT – statutory construction – respondent charged with responsibility for making finding as to whether activity is core R&D activity – demarcation between definitional and operational provisions contained within Division 355 of the Income Tax Assessment Act 1997 – consideration of whether tax offsets would be available under operational provisions irrelevant to determination of whether definition of core R&D activity is satisfied
Extract from ITAA97
Division 355 – Research and Development –
Section 355-1 – What this Division is about
An R&D entity may be entitled to a tax offset for R&D activities. The tax offset may be a refundable tax offset if the R&D entity’s aggregated turnover is less than $20 million.
To be entitled to the tax offset, the R&D entity needs one or more notional deductions under this Division.
There are 2 main kinds of notional deductions. One is for expenditure on R&D activities. The other is for the decline in value of tangible depreciating assets used for R&D activities.
Note: All of these notional deductions require the R&D entity to be registered for the R&D activities under Part III of the Industry Research and Development Act 1986 .
S355-25 – Core R&D activities
(1) 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:
(i) is based on principles of established science; and
(ii) 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).
(2) However, none of the following activities are core R&D activities :
(a) market research, market testing or market development, or sales promotion (including consumer surveys);
(b) prospecting, exploring or drilling for minerals or * petroleum for the purposes of one or more of the following:
(i) discovering deposits;
(ii) determining more precisely the location of deposits;
(iii) determining the size or quality of deposits;
(c) management studies or efficiency surveys;
(d) research in social sciences, arts or humanities;
(e) commercial, legal and administrative aspects of patenting, licensing or other activities;
(f) activities associated with complying with statutory requirements or standards, including one or more of the following:
(i) maintaining national standards;
(ii) calibrating secondary standards;
(iii) routine testing and analysis of materials, components, products, processes, soils, atmospheres and other things;
(g) any activity related to the reproduction of a commercial product or process:
(i) by a physical examination of an existing system; or
(ii) from plans, blueprints, detailed specifications or publically available information;
(h) developing, modifying or customising computer software for the dominant purpose of use by any of the following entities for their internal administration (including the internal administration of their business functions):
(i) the entity (the developer ) for which the software is developed, modified or customised;
(ii) an entity * connected with the developer;
(iii) an * affiliate of the developer, or an entity of which the developer is an affiliate.