D. THE REASONS
24 On 6 December 2023, the Tribunal affirmed the internal review decision and published the Reasons.
25 Following an introduction which identified some background matters and the decision under review (T[1] to [6]), the senior member set out or described the centrally relevant legislative provisions, including s 3 of the IR&D Act and ss 355-1, 355-5, 355-20, 355-25 and 355-30 of the ITAA 1997 (T[7] to T[16]).
26 Under the heading "Documentary Evidence", the senior member noted that "an absence of documentation evidencing the systematic progression of work undertaken in relation to claimed activities, where more extensive documentation is ordinarily an expected feature of that process, may suggest that the requirements of section 355-25 have not been satisfied". The senior member cited Lakes Oil NL and Innovation and Science Australia (Taxation) [2023] AATA 811 at [219] in support of that proposition (T[17]).
27 The senior member explained that 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 work (T[17]).
28 The senior member then referred to earlier cases "in which a lack of proper/relevant contemporaneous documents have been 'fatal'", namely Lakes Oil NL, Docklands Science Park Pty Ltd and Innovation Australia [2015] AATA 973, Royal Wins Pty Ltd and Innovation and Science Australia [2020] AATA 4320 and Coal of Queensland v Innovation and Science Australia [2021] FCAFC 54; (2021) 285 FCR 286 (T[18]). The senior member then quoted (at T[19]) from Rix's Creek Pty Ltd; Bloomfield Collieries Pty Ltd and Innovation Australia [2017] AATA 645, in which the (same) senior member had explained:
[20] … Evidence must be available to satisfy this requirement and that a vague, generalised description of the claimed activities is not sufficient to establish that a hypothesis was formulated and that the activities claimed were carried out.
[21] While the creation and provision of documentation is not a statutory requirement to substantiate the R&D activities, … documentary evidence is an expected feature of an activity that is systematic, investigative and experimental. Documentation is necessary to record the activity undertaken, its purpose, progress and, of course, the results of the activities and the evaluation of those results. Without such documentation, it is near impossible to establish the progression of the activities undertaken and that the purpose of the activities was to generate new knowledge in the form of new or improved materials, products, devices, processes or services. It follows, that without such documentation, the experimental activity would have limited application or future use…
29 The senior member concluded this section of the Reasons by recording her understanding that the records provided to the Tribunal comprised "the entirety of the documentary records created and kept by the applicant in relation to the Claimed Activities" (T[20]).
30 The senior member then addressed the Claimed Activities. The senior member first noted the applicant's contentions that:
(1) the Delly1 was a new and improved shoe specifically designed for Mr Matthew Dellavedova, an Australian basketballer, and was designed with and for him as a first genuine "signature shoe" in Australia; and
(2) the project, the first of its type for the applicant, resulted in a "new and improved shoe, in new knowledge and information, in respect of the shoe and the development of such a shoe" (T[21]).
31 After noting the manner in which the applicant had described the activities which had been carried out in the registration forms it had lodged (T[22]), the senior member expressed the view that there is a significant degree of overlap between the Claimed Activities, and how they are described in the registration forms; that all of the Claimed Activities are stated to form part of the same project, namely "Delly1", starting on 1 July 2015 with an expected completion date of 30 September 2018; and that each refers to the process of developing prototype shoes and testing them to obtain feedback for the development of the Delly1 (T[23]). The senior member then stated (at T[24]):
Activity 1.1 of the Claimed Activities is characterised as prototyping for tests and experiments and appears to have involved the manufacture of each Prototype by Quanzhou Peak Shoes Co, Ltd (PEAK) in China. It appears that any tests and experiments of the prototypes were undertaken as part of Activity 1.2 and 1.3. Given the characterisation of the Claimed Activities, they will be considered collectively as to whether they satisfy the statutory definition of core R&D activities.
(emphasis in original)
32 The senior member then recorded the applicant's contention that the development of the "Delly1" project included the activities and steps described in Mr Bickley's statement dated 26 August 2019; and the applicant's submission that the activities and steps there described extended beyond simple "trial and error" and involved active feedback in relation to the development of the shoe (T[25]). The senior member then set out Mr Bickley's evidence that:
The development of the Delly I took a long time, with many different prototype versions and development stages. There were many revisions and changes. There were many failures and situations where we had to go back to the drawing board. It was not a case of simply taking an existing off-the-shelf shoe, modifying it a bit for a player's preferences and then putting the player's name on the shoe. Numerous hand-made prototype versions were made - bespoke shoes, designed and created only for testing. The Delly I was engineered.
(emphasis in original)
and noted that annexed to Mr Bickley's statement dated 26 August 2019 was a document titled "Delly1 Prototype Development History" detailing each iteration of prototypes created, with a description of the alleged activities and testing undertaken. The senior member referred to this document as the Development History and set out a detailed description of relevant aspects of the Development History.
33 At T[27] to [28], the senior member dealt with contemporaneous evidence adduced by the applicant, stating:
27. In addition to the Development History, the applicant has provided some contemporaneous evidence of the carrying out of the Claimed Activities, including photographs of each prototype; videos of Mr Dellavedova's feedback of prototype 3; video testing of Prototype 4 (Video_testing - 1.07.16); WeChat messages from late June to early July 2016 and October 2016 in relation to Prototype 4; emails dated 30 August 2016 and 15 September 2016 from Mr Dellavedova's manager, Mr Bruce Kaider, to Ms Christin Wu of PEAK relating to Prototype 4.
28. I note here that Video_testing - 1.07.16, while described by Mr Bickley as showing Mr Dellavedova testing prototype 4 during a training session, it was plainly taken for promotional purposes which was subsequently shared to the Twitter account of PEAKSportAus to promote the Delly1. There is no evidence of the applicant actually using the video to evaluate Prototype 4. At hearing, Dr Habil Thorsten Sterzing, a scientist in the field of athletic footwear research and development, discussed the video and its application. When asked if he could judge the performance of the shoe by the video, he said it was hard to see how certain components of the shoe perform. I wouldn't be able to check on the real foot counter whether it improves stability or not. I wouldn't see whether the foot rolls over and pushes the mesh over the midsole. That video would not allow me to judge on it and the image is not detailed enough to see what really happens in terms of shoe information, the material and whether it restricts, facilitates or allows movement. Dr Sterzing gave evidence that in his experience, he has used video footage of testing sessions to assess the performance of a prototype of an athletic shoe, but in a way more specific way and not in a general way like seen in this style of video. He agreed that high-speed video footage was usually used, as well as infra-red motional analysis systems, and markers on the floor and the body of the athlete. Dr Sterzing added that when he undertook testing of this kind, he usually had a second shoe, a comparative shoe, that as systematically altered, I see how that shoe compares to another shoe; as a matter of what you call standardisation of the evaluation. You have a shoe, ideally isolated and systematically altered, and you ask the person to do exactly the same thing. Human locomotion is never exact, but for the layman, the same movement. That allows me to compare the functionally of two shoes.
(emphasis in original)
34 The senior member then noted that the applicant had also provided emails from basketball players Mr Scott Freer and Mr Damien Martin each of which was dated in late April 2023 (i.e. in the days before the hearing commenced on 1 May 2023) (T[29]). The senior member described those emails as follows (T[29]):
They are not contemporaneous records and provide retrospective evidence of the players' feedback in relation to the Delly1 shoe, recalled at least 6 years after testing. Most significantly, there are significant issues with the evidence contained in the emails. Mr Freer and 30-40 other players apparently tested the "off the shelf" existing PEAK product, referred to as Prototype 1, but as Mr Bickley's evidence shows, the shoe provided to "other players" was not the version of Prototype 1 tested by Mr Dellavedova. The version of prototype 1 provided to Mr Dellavedova had minor changes. Mr Martin apparently tested Prototype 6, the production version, but in the Development History, Mr Bickley stated that the applicant did not give the production versions to anyone other than Mr Dellavedova to test.
(emphasis in original)
35 The senior member then expressed the following views (at T[30] to T[31]):
30. There is no documentary evidence of work undertaken by PEAK as part of the process to develop the Delly1 prototypes, other than the fact that it manufactured the prototypes. There is no evidence as to whether PEAK was attempting to formulate any scientific or technical hypotheses in relation to each Prototype. The available evidence suggests that PEAK was simply responding to instructions from Mr Dellavedova, either directly, or as relayed by Mr Bickley.
31. Also, I note that there is a relevant and substantial inconsistency in the evidence regarding Prototype 1. The Development History and in Mr Bickley's statement, prototype 1 was described as a "shoe that was not available for sale or off the shelf" however in further written submissions from the applicant, and in the oral evidence of Mr Bickley, it is apparent that the manufacture of the first prototype started largely with an existing PEAK product.
(emphasis in original)
36 The Reasons continued, under the heading "Consideration". The senior member's analysis started with consideration of whether the outcome of the Claimed Activities could not have been known or determined in advance on the basis of current knowledge, information or experience (i.e. the first limb of s 355-25(1)(a) being the first characteristic described at [6] above). The senior member expressed the following views at T[32] to [37]:
32. The 'outcome' for the purposes of the statutory test is the outcome of the experimental activities in question. While the precise data produced by the work undertaken could not have been known in advance, it does not necessarily follow that the work constituted an activity whose outcome could not have been known or determined in advance on the basis of current knowledge, information, and experience; Coal of Queensland v Innovation and Science Australia (2021) 285 FCR 286 at [101].
33. In respect to the whole project, it is unclear precisely what unknown outcome the applicant was seeking to determine, other than to create a basketball shoe which satisfied Mr Dellavedova's specific requirements. It is accepted that the requirements of Mr Dellavedova could not have been determined in advance. However, I am not convinced that this is an outcome directed to a technical or scientific uncertainty. It is a subjective outcome and one outside of the control of the applicant.
34. Considering the prototype specific outcomes, it is unclear on the evidence specifically what modifications took place between the various prototypes, and to what degree. The descriptions of the modification in the Development History are in very general and vague terms. Even so, the general outcomes could have been known in advance.
35. The only available evidence from a competent professional in the relevant field of shoe design is that of Dr Sterzing. He has expensive industry experience in the field of athletic shoe development. He gave evidence about the availability of low-cut basketball shoes on the market since 2008; and he gave evidence about numerous journal articles and research around modifications made to aspects of shoes to affect functionality and performance.
36. Mr Bickley, who is not an expert in shoe design, gave evidence that he was able to "tell" from his personal examination of each Prototype whether it was going to be suitable or would meet Mr Dellavedova's needs. For example, he would tell if a prototype was lighter, or more flexible. The applicant also submitted that a modification with an unknown outcome, was the mesh upper. However, Mr Bickley's evidence was that he was able to "tell" that in relation to the mesh upper, the prototype was stronger in the upper, had additional stiffness and a reduction in movement, suggesting that there was no uncertainty to test whether the mesh upper made the upper stronger. The evidence of Mr Bickley also shows that PEAK suggested the use of the mesh upper to help reduce the weight of the shoe. It can be inferred from this evidence that the outcome of using the mesh upper was known, in that it made the shoe lighter.
37. There is no evidence to establish that the outcomes of specific modifications made to the prototypes could not have been known in advance.
(bold emphasis added)
37 The views expressed by the senior member in the final two sentences of T[33] are the subject of the second question of law and the third and fourth grounds of appeal advanced by the applicant.
38 The senior member then considered whether the outcome of the Claimed Activities could only be determined by applying a systematic progression of work based on principles of established science, which proceeded from hypothesis to experiment, observation and evaluation, and which leads to logical conclusions (i.e. the second limb of s 355-25(1)(a), being the second characteristic discussed at [7] above). The senior member expressed the following views at T[38] to [51]:
38. The term 'hypothesis' is not defined in the ITAA 1997 and should be given its ordinary meaning. It is plain that a hypothesis must have a scientific basis. This is enforced by section 355-5(2) which provides that the object of the ITAA 1997 is to be achieved in a "scientific way". Additionally, section 355-25 specifically provides that experimental activities must not only proceed from hypothesis to experiment, but they must also be "based on principles of established science"; see Lakes Oil NL and Innovation and Science Australia (Taxation) [2023] AATA 811 at [206].
39. The applicant submits that while they may be described or stated the hypothesis in different ways, they are essentially referring to the same thing, the same "particular actions". The Development History records that "we were testing this prototype to see if it would meet Matthew's requirements". The asserted hypothesis found throughout the Development History to test:
(a) to see if prototype 1 would meet Mr Dellavedova's requirements for a low-cut shoe that was light and close to the ground, with sufficient support and traction, suitable to his playing position and style;
(b) the softer upper, a completely different outsole, and the additional heel support to see how that felt and whether it would meet Mr Dellavedova's requirements;
(c) whether the revised prototype provided additional flexibility in the upper, offered a sufficient reduction in weight and was low enough;
(d) the new outsole, for grip, traction, and cushioning, as well as examining how the lower profile outsole would perform;
(e) the revised upper, as the applicant did not know whether this would provide enough support in the front part of the shoe, with roll‑ out/push-out by Mr Dellavedova's foot;
(f) a revised heel counter designed in response to changes to the outsole and the upper, to see whether this provided sufficient support for Mr Dellavedova;
(g) whether the strengthened mesh under the 3D printed KPU provided additional stiffness and a reduction in the movement of the upper and sidewall. To test the revised heel counter, to determine if it provided sufficient support;
(h) the revised outsole to see if it provided enough additional cushioning and support and testing the revised heel counter, to check whether this provided sufficient support; and
(i) whether the production versions performed in the same way as the handmade prototype.
40. There is no contemporaneous evidence that the applicant formulated these asserted hypotheses before carrying out either the manufacture of each prototype or the testing of each prototype. The need for contemporaneous evidence of the formulation of a hypothesis is especially important, given it is the essential starting point of the activities and identifies the outcome sought to be achieved.
41. The evidence does not demonstrate how each hypothesis was tested on each iteration of prototype and how the outcomes were recorded and observed. It also appears on the evidence that feedback provided by Mr Dellavedova on certain prototypes did not relate to the asserted hypothesis. Most significantly, in regard to prototype 3, where feedback provided focused on outcomes related to the shoe eyelets, tongue, toe box, and peeling of the outsole, when these aspects of the prototype were not identified in the asserted hypothesis for testing. It is unclear how these outcomes were factored into the evaluation of the prototype.
42. Dr Sterzing opined at hearing that the hypothesis put forward are rather objectives and description of what was done and were not hypotheses in the way that postulate a certain fact to be verified.
43. Dr Peter Ellerton, lecturer and philosopher of science, has provided a report in these proceedings dated 23 November 2020. Dr Ellerton gave evidence about the formulation of a hypothesis. He said at hearing, it's difficult to see, in fact, how you could do further testing without developing some kind of hypothesis. So at some stage the hypothesis must have been developed and improved and where that occurred I don't know. When discussing the hypothetico-deductive method, Dr Ellerton accepted in cross-examination that, the outcome of a hypothesis is uncertain until it is tested. This is the purpose of the test.
44. There is 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, the evidence of Mr Bickley was that he was able to anticipate and predict whether certain features and modifications were not going to meet Mr Dellavedova requirements. It is also apparent on the evidence that Mr Bickley provided feedback and PEAK made suggestions about materials and modifications of the shoe, anticipating how particular changes to the features of the shoe between prototypes would impact the shoe's functionality. While I accept that there is some uncertainty around whether the modifications would satisfy Mr Dellavedova's requirements, I am not convinced that this uncertainty is an unknown outcome in the context of developing a hypothesis.
45. The available evidence demonstrates that iterations of prototypes were manufactured by PEAK and the applicant conducted testing of the prototypes. The precise nature of the testing undertaken by the applicant for each prototype is not documented with any precision. It appears that the main testing undertaken was that prototypes were manufactured by PEAK starting with an existing PEAK product, feedback was provided either directly to PEAK or via the applicant to PEAK about subjective requirements or issues identified by Mr Dellavedova.
46. In his report, Dr Sterzing relevantly stated:
[33] As different components of a shoe construction may interact with each other, thereby resembling confounding factors to causal conclusions made regarding the functional effects of one specified shoe component, ideally only one component of a shoe construction is advised to be altered in science based research and development endeavours.
[34] In addition, such isolated shoe alteration typically takes place in graded approaches during which prototypes are built for direct comparison within one test session (for instance, Brauner et al 2009, Guo and Stefanyshyn 2011, Oriwol et al 2011). This allows determining the desired degree of a shoe alteration for a specific shoe feature, for instance the optimal degree of outsole traction during court sport movements for a specific target group (Guo and Stefanyshyn 2011). Such an approach allows to generate systematic knowledge regarding the type, the physical properties, and the processing of materials applied to achieve mechanical properties that subsequently influence the actual objective and subjective shoe performance of athletes.
47. There is no evidence about how Mr Dellavedova actually tested each prototype, other than that he wore each prototype either in training conditions or during play. The testing undertaken by Mr Dellavedova did not consist of repeatable, verifiable tests capable of isolating the effects of each of the design modifications actually being tested. As Mr Sterzing's evidence provided, where multiple modifications were made on a prototype at one time, it would have been unclear what change or feature at each iteration was impacting on the overall shoe performance, other than mere speculation. Mr Dellavedova's feedback was not technical in nature, but more along the lines of subjective feedback.
48. It also appears that Mr Bickley tried on some iterations of the prototypes and provided feedback. What utility this would have had, given that the scientific basis for any such testing was undefined nor verifiable, would be limited. Other athletes allegedly tested a version of prototype 1. But as discussed earlier, the prototype tested was merely a stock model manufactured by PEAK. Any other feedback provided by athletes of other later iterations of prototypes was not recorded and, in any event, appeared to be vague and subjective in nature without any technical basis.
49. I accept that designing the Delly1 was a process. But as Dr Sterzing opined, in the circumstances of the development of Delly1, it's not necessarily a scientific process. It is more likely that the process undertaken to develop the Delly1 was one of trial and error, with the assistance of PEAKs knowledge of materials and shoe design. It was more akin to knowledge discovery and a problem-solving process rather than an experimental activity based on established scientific principles.
50. While Dr Ellerton opined that the Claimed Activities separately and collectively constituted a systematic progression of work based on established principles of science that proceed from hypothesis to experiment, observation and evaluation, and lead to logical conclusions, I do not accept that to be the case for the reasons already detailed. Additionally, I note that he inferred that the relevant physical principles must have been followed simply from the fact that the shoe was ultimately developed into a commercial product. Such an inference is outside of Dr Ellerton's expertise. Dr Ellerton has no knowledge of the procedural principles applicable to athletic shoe research and development.
51. Further, Dr Ellerton's reasoning expressed in his report in arriving at his opinions was very generalised. However, based on his report and oral evidence, it is apparent that Dr Ellerton's opinions were based on assumptions about the level of involvement of Mr Bickley and the applicant in the development of the shoe. He recorded in his report that he understood that the applicant generated a sequence of prototypes and that the prototypes were designed by [the applicant]. Dr Ellerton said at hearing that he understood those responsible for testing the prototypes and redesigning it, including Mr Bickley, were responsible for analysing results of testing. He agreed that he had assumed someone somewhere has to take accord of that information and make a modification to that effect and that that was the process of analysis. He said he also assumed that because there were some modifications to the next prototype, there must have been some analysis. This is despite the absence of adequate contemporaneous, quantitative evidence recording the results of testing allegedly undertaken in respect of each prototype. Dr Ellerton's evidence was simply that the feedback provided by Mr Dellavedova was valid and verifiable as it was given by the person testing it and by the person for whom the shoe is designed and was simply verifiable by anybody else who asked Mr Dellavedova, to use his example, what his experiences were of that shoe, he would give the same response.
(emphasis in original)
39 The senior member expressed the following conclusion (at T[52]) as to the second limb of s 355-25(1)(a):
For these reasons, I am not satisfied that 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.
40 Having dealt with both limbs of s 355-25(1)(a), the senior member then turned to s 355-25(1)(b) - whether the Claimed Activities were conducted for the purpose of generating new knowledge (being the third characteristic, discussed at [8] above). After noting that the term "new knowledge" is not defined by the ITAA 1997 and takes its ordinary meaning, the senior member stated at T[53] to T[55]:
53. ... In the context of Division 355 of the ITAA and the IR&D Act, the new knowledge sought to be generated is not defined by the subjective knowledge or experience of the R&D entity, and the concept of new knowledge must be construed in context, as a feature of the 'experimental activities'.
54. As stated, the claimed activities were conducted for the purpose of developing a product that could be marketed as Mr Dellavedova's 'signature shoe' and the claimed activities were conducted for the purpose of determining what modifications of previously known athletic shoe design features would suit the personal preferences or requirements of Mr Dellavedova. As discussed in detail in these reasons, the iterations of the prototypes manufactured by PEAK, were modified based on feedback provided by Mr Bickley and Mr Dellavedova to PEAK, relying on PEAKs knowledge and experience with shoe manufacturing and design to provide solutions. The evidence does not demonstrate that 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.
55. The applicant submits that the addition of the mesh to the upper was new knowledge. In the Development History, it was recorded that the applicant was testing whether the strengthened mesh under the 3D printed KPU provided additional stiffness and a reduction in the movement of the upper and sidewall and this process, the 3D printing, was first introduced, and it was the first time it had been done on a shoe...PEAK advised Mr Bickley that the 3D printed mesh was a new manufacturing process that they would use for this prototype and it was new to basketball shoes generally, but it was certainly new to PEAK. However, Mr Bickley's oral evidence was that the feedback was that the shoe was too heavy and clunky, and the mesh upper was PEAK's suggestion. The decision to use that particular type of material would have been PEAKs decision, Mr Bickley said that the decision to change the material of the upper to lighter weight material was his, given to PEAK to find a solution. This evidence demonstrates that the development and manufacture of the mesh upper was plainly undertaken by PEAK. There is no evidence to demonstrate that the applicant 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.
41 The senior member recorded at T[56] that she was "not satisfied that the Claimed Activities were conducted for the purpose of generating new knowledge".
42 The senior member's ultimate conclusions were expressed at T[57] and [58] as follows:
57. None of the Claimed Activities were core R&D activities within the meaning of subsection 355-25(1) of the ITAA 1997. Rather, the Claimed Activities consisted of the modification of previously known athletic shoe design features to suit the personal preferences or requirements of an individual player, namely Matthew Dellavedova. Accordingly, none of those Activities can be supporting R&D activities for the purposes of subsection 355-30(1) of the ITAA 1997.
58. The decision under review is affirmed.
43 In summary, the applicant failed to establish both limbs of s 355-25(1)(a); and s 355-25(b) of the ITAA 1997.