AAT affirms Commissioner’s authority to assess R&D eligibility

The Administrative Appeals Tribunal (AAT or ‘the Tribunal’) has upheld a decision by the Commissioner of Taxation on the eligibility of R&D activities, thereby affirming the Commissioner’s authority to do so.

We explore GQHC and Commissioner of Taxation (Taxation) [2024] AATA 409, and the implications of the tribunal’s finding for other businesses seeking to claim their research and development (R&D) activities under the R&D Tax Incentive (R&DTI).

A brief summary of the case

GQHC is part of an 80-year-old family-owned poultry operation. The case in question pertains to R&D activities claimed by GQHC in the 2012/13 financial year.

In that year, GQHC’s chicken feed was classified as feedstock input expenditure, with the result that GQHC effectively received no R&D tax benefit for the feed expenditure.

GQHC filed an objection to its 2013 Notice of Assessment, which the Commissioner of Taxation disallowed. Subsequently, GQHC applied to the Tribunal to review the Commissioner’s objection.

The key issues in question:

  • Whether the feed expenditure incurred on the R&D activities should be included in GQHC’s assessable income as a feedstock adjustment in accordance with Subdivision 355-H of the Income Tax Assessment Act 1997 (ITAA 1997).
  • Whether the registered R&D activities in the 2012/13 financial year were eligible R&D activities within the meaning of Section 355-20 of the ITAA 1997.
  • Whether the Commissioner has the jurisdiction to determine the eligibility of registered R&D activities.

Outcome: The Tribunal upheld the Commissioner’s decision and affirmed its authority to assess the eligibility of R&D activities.

Since the inception of the R&D Tax Concession in 1986, it has been considered the remit of the Industry, Innovation and Science Australia (IISA) Board (which delegates its authority to AusIndustry) to monitor the eligibility of registered R&D activities. This is the first published case where the ATO has challenged activity eligibility. Because the ATO views R&D activities through a different lens than AusIndustry, the Tribunal’s decision to uphold the challenge has potential implications for the R&D activity review process.

The case and issues in detail

Background

GQHC’s vertically integrated chicken business rears and lays eggs, then grows the hatched chickens for consumption (referred to as “broiler” chickens). Since 2006, the company has been claiming R&D tax under the R&DTI and its predecessor, the R&D Tax Concession.

GQHC claimed the R&D activities in question during the 2012/13 financial year. These activities cover various processes within the poultry production system, including the incubation and hatchery process, the quality of poultry water, shed decontamination, and feed trials aimed at improving broiler growth outcomes.

From 2006, IISA conducted three formal reviews of GQHC’s registered R&D activities. Interestingly, none of these reviews resulted in a negative finding with respect to the eligibility of GQHC’s registered R&D activities.

In 2013, the chicken feed—a formulated grain-based food source fed to the broiler chickens—was classified as feedstock input expenditure used in the R&D activities. As a result of this classification, GQHC did not receive an R&D tax benefit for claiming the feed expenditure – only the Section 8-1 deductions to which it was ordinarily entitled.

However, in light of a previous decision in GHP 104 160 689 Pty Ltd and Commissioner of Taxation [2014] AATA 869 (GHP), GQHC filed an objection to its 2013 Notice of Assessment. This objection was based on the principles outlined in the GHP case. Among other requests, GQHC asked that the Feedstock Conversion Rate be used to determine the portion of feed expenditure—not the entire feed expenditure—that is attributed to the feedstock outputs, namely, the processed chicken meat and eggs.

The Commissioner disallowed GQHC’s objection, denying any apportionment of the feed expenditure and determining the entire feed expenditure to be used as the basis for adjusting GQHC’s assessable income. Subsequently, GQHC applied to the Tribunal to review the Commissioner’s objection. It was at this point that the Commissioner notified GQHC of its contention regarding the eligibility of GQHC’s registered activities.

Issue one: Feedstock adjustment to assessable income

R&DTI feedstock rules

Broadly, the R&DTI feedstock rules operate to remove the additional R&D tax benefit, or the ‘incentive component’, when the company receives a benefit from the tangible products produced by the R&D activities.

It is also important to note that the feedstock rules of the R&DTI are consistent with the previous R&D tax concession. However, under the R&DTI, the R&D entity’s assessable income is adjusted commensurate with the value of the R&D-produced products.

The Tribunal’s finding

The Tribunal found that, had eligible R&D activities been undertaken, then GQHC’s feed and chickens would be transformed or processed during the R&D to produce a tangible product. Accordingly, the chicken feed was classified as feedstock input expenditure and required an adjustment to GQHC’s assessable income pursuant to Subdivision 355-H of ITAA 1997.

BDO comment

Given the similarity between the feedstock provision within Division 355 of the ITAA 1997 (Division 355) and the superseded definition in 73(B) of the ITAA 1936, it is surprising that the Tribunal did not consider the legislative history of Subdivision 355-H. Had they done so, the Tribunal might have considered the findings in GHP, which is the industry’s reference case on feedstock expenditure. The findings provide frameworks to assess the links between feedstock inputs and feedstock outputs and to determine whether the feed is itself subject to transformation or processing during R&D activities, or whether the feed subjects other goods and materials (i.e. the broilers) to transformation or processing during R&D activities.

Considering GQHC’s initial objection, it is puzzling that there was a lack of statutory interpretation of Subdivision 355-H, particularly with respect to the amounts attributable to the production of the feedstock output as defined in Subsection 355-465(2)(b). The Tribunal’s decision to deny any apportionment of the cost of feed, on the grounds that all feed was required to produce the final output, appears to be an oversimplification of the complex links between feed and outputs of the poultry production system.

Issue two: R&D activity eligibility

The Tribunal’s finding

The Tribunal found that none of the registered activities met the criteria of a core R&D activity as defined by Section 355-25 of the ITAA 1997. The Tribunal concluded that none of the registered activities were undertaken in a manner based on the principles of science. In reaching its decision, the Tribunal chose to align core R&D activity eligibility more closely with the style of research activities undertaken in academic environments. This decision appears contradictory to the findings in PKWK V Innovation and Science Australia (Taxation) [2021] AATA 706, which sought to align R&D activity eligibility from within the context of research conducted in industry-based environments. 

BDO comment

The Tribunal’s alignment of core activity eligibility to academic research is most clearly demonstrated in its acceptance of the expert’s evidence. The accepted evidence seems to suggest that industry-based R&D activities should incorporate academic-style research practices, such as adequate replication and the identification of knowledge gaps solely within scientific literature. By accepting this evidence, the Tribunal has imposed a higher threshold for R&D activity eligibility, which for some industries will be impractical to achieve. This heightened eligibility threshold will lead to the exclusion of activities from certain industries that were previously considered eligible industry-based activities.

Issue three: The Commissioner’s jurisdiction

The Tribunal’s finding

In appealing to the Tribunal, GQHC contended that the Commissioner does not have jurisdiction to assess the eligibility of GQHC’s registered R&D activities - as defined by Division 355 - stating that pursuant to the Industry Research and Development Act 1986 (IR&D Act 1986), only the Board has the power to assess the eligibility of R&D activities under the R&DTI.

Ultimately, the Tribunal was heavily influenced by the obiter dicta of the Full Federal Court in Commissioner of Taxation v Auctus Resources Pty Ltd [2021] and, found that in the absence of a finding by the Board, the Commissioner has the jurisdiction to assess the eligibility of R&D activities as defined by Division 355 in its general administrative power and duty to assess a taxpayer’s liability. 

BDO comment

This is the first case where the Commissioner, rather than the IISA Board, has assessed the eligibility of an entity’s registered R&D activities. The Tribunal’s findings are significant because they centralise the Commissioner’s assessment powers, which is contrary to the intention of Australia’s dual agency administration model. Further, it seems to overlook the intentional separation of roles provided under the IR&D Act 1986. As a result of this decision, there is now considerable uncertainty within the program as to which agency will ultimately assess the eligibility of R&D activities and more specifically, which compliance auditing framework will be employed in assessing R&D activities.

A final BDO comment

BDO welcomes the comments made in the recently published Decision Impact Statement, indicating that the Commissioner will continue referring R&D activity eligibility matters to the board. Nevertheless, we are concerned with the administration ambiguity introduced by this decision. We believe that to reduce administration ambiguity and improve the program’s overall effectiveness, the responsibilities and limitations of each agency should be clearly defined within the relevant legislation.

Our team of R&D specialists provide expert guidance to help you navigate the complexities of successfully claiming R&D activities. Contact us to find out whether your organisation might be eligible for benefits.