This is an appeal from the decision of the Administrative Appeals Tribunal in H2O Exchange Pty Ltd and Innovation and Science Australia  AATA 4195. H2O Exchange (H2O) was developing an online water exchange that would allow the sale and purchase of water rights in the Murray-Darling Basin within New South Wales, Victoria and South Australia. One of the Core Activities it identified was development of a core trading platform and data base which included:
(1) a web-based trading platform that “a customer or broker can directly access, and list buy or sell orders for water entitlements and water allocation”;
(2) a membership database and CRM, to record client data and details of their water assets;
(3) a binding legal framework, where the placing of buy and sell orders which once matched forms a binding legal contract;
(4) real-time settlement and payment of fees; and
(5) complete automation of the conveyancing and registration process, including updating of title registries and water accounting systems by water authorities in each State.
H20’s application was denied by AusIndustry (acting for Industry & Science Australia) the AAT and by the Federal Court on appeal. This case has several lessons for R&D applicants.
Lesson 1: Just because it is new or different doesn’t mean it is also R&D
To meet the statutory test of a Core Activity and gain the benefit of the R&D tax incentive the activity must be one whose outcome could not be known or determined in advance based on current knowledge, information or experience, but could 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. If what is done can be accomplished easily by a competent professional even if it involves complicated work, this does not create uncertainty of outcome.
Lesson 2: Current knowledge, information or experience is a broad term which has no specific meaning
AusIndustry assesses whether an outcome can be determined in advance using current knowledge by reference to whether it could be “simply and easily accomplished by a competent professional” using the words of the AAT in H2O. What is known or not known, whether the outcome of an activity can be determined in advance, and what a competent professional thinks can be determined in advance has no legal standard and is open to wide individual interpretation.
The burden of proof is on the Applicant to demonstrate what the baseline knowledge or experience is. Following a multipart proof process helps:
A. State the features of your development outcome that differ uniquely from what exists in the marketplace today
B. List what you know about how to develop these differentiating features
C. List what you don’t know or want to find out. State why these things cannot be known and why they are important to the design outcome. This is often done by listing the factors and constraints (variables) that might influence the answer, and stating what you know and don’t know about how they interact or influence the design outcome.
D. Turn these unknowns into specific technical questions. The more specific the question and the more it refers to the influencing variables the easier it is to show how the question cannot be answered in advance and requires a process of experimentation to find the answer.
E. Document this process before you start your experiment. Whilst this will not protect you against audit activity it is best practice.
This process sets the context for how the Core Activity is described, namely as experiments to answer the questions posed. These experiments begin with a set of hypothesised answers to each question that you want to prove or disprove. The experiments themselves become the detailed design activities, tests, insights and learnings that you go through to get answer the question.
One failing in the H2O application was that it did not adopt this style of process. If it had it might have decided that the development had few activities that met the definition of R&D.
Lesson 3: A “competent professional” does not mean an expert in the field. It can mean someone with relevant experience in the market in which you operate.
In H2O, Ausindustry found an ‘expert’ witness who had a Bachelor Finance degree and experience in the trading of water rights to assert that the development of a trading platform was simple and easy. The witness had no formal computer software qualifications, programming expertise and had never written a line of code but had ‘specialised experience’ in being part of various database and CRM design teams, most relevantly at Waterfind Pty Ltd as manager of its Market Services division. The Waterfind platform is an online marketplace that automatically matches compatible buy and sell orders and creates a binding legal contract. The witness had a comprehensive understanding of the water market regulations and conveyancing rules across all states, as well as knowledge of trading behaviour and market clearing systems where This experience was enough to qualify him as a competent professional even though he could not have written the trading platform himself.
In this day and age where access to information seems to make everyone an expert, and every expert experienced in their craft has an opinion as to whether an outcome can be known in advance or not, you don’t want to end up in Court. It is far better to document and articulate your R&D applications in the right way from the start.