Active Sports Management Pty Ltd and Industry Innovation and Science Australia
[2023] AATA 4078
•6 December 2023
Active Sports Management Pty Ltd and Industry Innovation and Science Australia [2023] AATA 4078 (6 December 2023)
Division:TAXATION AND COMMERCIAL DIVISION
File Number(s): 2019/8208
Re:Active Sports Management Pty Ltd
APPLICANT
AndIndustry Innovation and Science Australia
RESPONDENT
DECISION
Tribunal:Senior Member A Poljak
Date:6 December 2023
Place:Sydney
The decision under review is affirmed.
............................[SGD]............................................
Senior Member A Poljak
Catchwords
TAXATION – Research and development - R&D Tax Incentive – Whether activities undertaken by the Applicant are eligible research and development activities under the Industry Research and Development Act 1986 (Cth) and Income Tax Assessment Act 1997 (Cth) – Decision under review affirmed
Legislation
Income Tax Assessment Act 1997 (Cth)
Industry Research and Development Act 1986 (Cth)
Cases
Coal of Queensland v Innovation and Science Australia (2021) 285 FCR 286.
Docklands Science Park Pty Ltd and Innovation Australia [2015] AATA 973
Lakes Oil NL and Innovation and Science Australia [2023] AATA 811
Rix’s Creek Pty Ltd; Bloomfield Collieries Pty Ltd and Innovation Australia [2017] AATA 645
Royal Wins Pty Ltd and Innovation and Science Australia [2020] AATA 4320
Secondary Materials
Replacement Explanatory Memorandum to the Tax Laws Amendment (Research and Development) Bill 2010
REASONS FOR DECISION
Senior Member A Poljak
6 December 2023
Active Sports Management Pty Ltd, the applicant, carries on a business which includes importing and selling sports apparel, footwear, accessories, hoodies, and tracksuits, among other things. It also designs and develops products for the Australian market or with unique Australian features and styles.
The respondent, Industry Innovation and Science Australia, (IISA) is jointly responsible with the Commissioner of Taxation for the administration of the R&D Tax Incentive scheme, established by Division 355 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) and the Industry Research and Development Act 1986 (Cth) (IR&D Act), for entities engaged in research and development activities (R&D Tax Incentive). The R&D Tax Incentive is administered on behalf of the respondent by the Department of Industry, Science and Resources.
By applications lodged in respect of the 2015-16 income year and the 2016-17 income year (the Applications), the applicant applied for registration of the following activities as “core R&D activities” for the purposes of the IR&D Act (the Claimed Activities):
For both the 2015-16 and the 2016-17 income years:
(a)Activity 1.1 – Prototyping for tests and experiments; and
(b)Activity 1.2 – Tests and experiments.
For the 2016-17 income year only:
(a) Activity 1.3 – Other tests and experiments.
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, an Australian professional basketball player who at that time played in the National Basketball Association in the United States of America.
On 6 May 2019, following examination of the applicant’s 2015-16 and 2016-17 registrations, the respondent determined under section 27J of the IR&D Act that none of the claimed activities satisfied the definition of “R&D activities”.
On 8 November 2019, following an internal review, the respondent confirmed the decision notified on 6 May 2019, that pursuant to section 27J of the IR&D Act, the claimed activities are neither core nor supporting R&D activities. This is the decision under review in these proceedings.
Relevant Legislative Provisions
The object of the IR&D Act, as stated in section 3, is to position Australia as a leading innovation nation by:
(a) facilitating the provision of independent strategic advice about investment in industry, innovation, science and research; and
(b) supporting and encouraging collaboration in the development and delivery of programs relating to industry, innovation, science and research; and
(c) authorising spending on programs relating to industry, innovation, science and research; and
(d) promoting the development, and improving the efficiency and international competitiveness, of Australian industry by encouraging R&D activities, innovation
and science activities and venture capital activities
Provisions concerning research and development are set out in Division 355 of the ITAA 1997. Section 355-1 of the ITAA 1997 provides an “R&D entity” may be entitled to a tax offset for “R&D activities”. It is accepted that the applicant is an R&D entity.
Section 355-5 sets out the object of the Division as follows:
(1) The object of this Division is to encourage industry to conduct research and development activities that might otherwise not be conducted because of an uncertain return from the activities, in cases where the knowledge gained is likely to benefit the wider Australian economy.
(2) This object is to be achieved by providing a tax incentive for industry to conduct, in a scientific way, experimental activities for the purpose of generating new knowledge or information in either a general or applied form (including new knowledge in the form of new or improved materials, products, devices, processes or services). [Emphasis added]
R&D entities are required to register annually with the respondent, in respect of an income year, before they can claim the R&D Tax Incentive. Registration does not conclusively render the activities eligible R&D activities (as defined by the ITAA 1997) and is not an indication of compliance with the statutory criteria.
For an entity to be correctly offsetting their tax pursuant to the R&D Tax Incentive they must be conducting R&D activities as defined under section 355-20 of the ITAA 1997. Section 355-20 of the ITAA 1997 defines R&D activities to mean “core R&D activities or supporting R&D activities”.
Section 355-25 of the ITAA 1997 defines core R&D activities as follows:
(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).
As to core R&D activities, the Replacement Explanatory Memorandum to the Tax Laws Amendment (Research and Development) Bill 2010 (Chapters 1 & 2) relevantly explains:
2.12 To qualify as core R&D activities, experiments will not merely confirm what is already known, or have an outcome that can be known or determined in advance. Rather, they will be activities whose outcome can only be determined by employing a systematic progression of work based on scientific principles and using an approach that proceeds from hypothesis to experiment, observation and evaluation and leads to logical conclusions. This approach is generally known as the scientific method.
2.13 The requirement for the scientific method establishes a threshold for the knowledge gap and the degree of uncertainty that an eligible experiment must seek to address. The threshold will not be met if the knowledge of whether something is scientifically or technologically possible, or how to achieve it in practice, is deducible by a competent professional in the field on the basis of current knowledge, information or experience.
2.14 Further, the nature of the eligible experiment is such that there will be a clear risk that the outcome of the experiment will not be the desired one. The potential for this risk to deter firms from undertaking knowledge-generating R&D underpins the rationale for the R&D tax incentive.
2.15 Less rigorous knowledge discovery and problem solving techniques, such as ‘trial and error’ alone will not be sufficient to qualify as eligible experimentation. However, trial and error may form part of an eligible experiment where the conditions for core R&D are met. Trial and error can also qualify as a supporting activity where it forms part of a decision to proceed to activities that qualify as core R&D.
2.16 Experimental activities that qualify as core R&D must be for the purpose of acquiring new knowledge or information. This requirement reflects the R&D tax incentive’s object of generating the knowledge benefits that arise from conducting R&D — rather than merely subsidising the application of the knowledge produced by R&D. This is particularly relevant where trials are repeated or prolonged, especially if carried out in a production context. The distinction between conducting R&D and applying the results of it (other than in further R&D) is a question of fact. ‘New knowledge’ in this context means knowledge not already available in the public arena at the time the activities are conducted, in the relevant technology, on a reasonably accessible world
wide basis.2.17 The requirement can be met by the purpose of acquiring or generating knowledge in the practical form of knowledge or information about the creation of new or improved materials, products, devices, processes or services. Where experimental activities occur in the context of normal production activities, the experiments may entail the direct production or use of an actual material, product, device, process or service.
2.18 The need to employ the scientific method also reflects the degree of novelty in the ideas being tested. That is, the knowledge being sought must go beyond validating a simple progression from what is already known and beyond merely implementing existing knowledge in a different context or location. Rather, the gap between existing knowledge and the hypothesis being investigated will be significant enough to require application of the scientific method.
[Emphasis added]Section 355-25(2) of the ITAA 1997 specifies particular activities which are taken not to be core R&D activities (excluded activities). The only potentially relevant excluded activity is:
(a) market research, market testing or market development, or sales promotions (including consumer surveys).
Supporting R&D activities are defined in subsection355-30(1) to mean “activities directly related to core R&D activities”.
Section 355-30 provides that activities are not supporting R&D activities where they are excluded under subsection 355-25(2), produce goods or services or are directly related to producing goods or services unless they are undertaken for the dominant purpose of supporting core R&D activities.
Documentary Evidence
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; Lakes Oil NL and Innovation and Science Australia [2023] AATA 811 at [219].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.
There are a number of Tribunal matters in which a lack of proper/relevant contemporaneous documents have been "fatal" to an application; see Lakes Oil NL and Innovation and Science Australia [2023] AATA 811, 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) 285 FCR 286.
In Rix’s Creek Pty Ltd; Bloomfield Collieries Pty Ltd and Innovation Australia [2017] AATA 645, the Tribunal 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…
It is understood that the records provided to the Tribunal in these proceedings comprises the entirety of the documentary records created and kept by the applicant in relation to the Claimed Activities.
Claimed Activities
The applicant contends that the Delly1 was a new and improved shoe, specifically designed for Matthew Dellavedova, a world-renown, Australian basketball player. It was designed with and for him, a first genuine ‘signature shoe’ in Australia. The applicant further contends that the project, a first of its type for the applicant, an Australian company, resulted in a new and improved shoe, in new knowledge and information, in respect of the shoe and the development of such a shoe.
In the registration forms, the applicant described the core activity which was carried out as follows:
Activity 1.1
“PEAK have developed many prototypes for this project with the dominant purpose being to do tests and experiments, to obtain data for the continual improvement of the project. Testing has been undertaken with many athletes both in Australia and in the USA, and continual refinement has taken place after each trial and test. Matthew Dellavedova has been integral to the testing process along with other athletes with different requirements. Different materials were trialled for different applications and new techniques were used for materials under different conditions. Some basketball players have specific requirements for shoe performance, depending on the position they play in on-court. PEAK have used different prototypes to develop different materials and used a combination of raw materials and designs to improve each prototype.
The development of each prototype has increased the understanding of better
performance for the project shoe. Peak believes that the new shoe can significantly improve the performance of players and reduce the negative effects of inferior design variables. So by reducing negative variables, there will be a safer and more efficient product.”Activity 1.2
"Regular testing and measuring of results means that PEAK are improving the new shoe with input from a number of players and retail focus groups. New prototypes have been tested during training sessions with Matthew Dellavedova and other elite athletes, to ascertain the suitability for different applications. A high degree of subjective evaluation by athletes provides data for improvement. This data is used to improve (or reduce) the strength, flexibility and cushioning of the various elements of each prototype. The data will determine where the weaknesses are and any vulnerabilities of the new shoe.
To complement the manufacture of a newly designed Outsole, Various Upper Lasts for the shoes have been used in incremental millimetre measurements of volume and elasticity. These are coupled with many Mid Sole inserts of various materials that provide a sliding scale of suitability for cushioning and comfort.
These tests are conducted systematically to obtain data and feedback to work with the technical designers to improve the product and support our conclusions in the production of the next prototype.”
Activity 1.3
“The development of the shoe has undergone many tests and prototypes. There have been a number of experiments conducted with different upper materials, in conjunction with various prototype outsoles. The result has been many months of specific testing with different combinations of outsole and upper materials.
…
The testing was conducted over many months in Australia, and overseas, only to compare results. The basis of many of these experiments were as follows:The anatomical requirements of the shoe were measured with individual Athletes. This required extensive examination of particular Athletes’ playing condition requirements, their particular physiological characteristics, and also the suitability of various materials to perform specific functions within various components of the shoe. Individual foot mouldings, body measurements and weights were recorded to identify individual characteristics that would guide product design.
Tests were conducted in professional Basketball environments in real time, during NBA team "training and competition. Material integrity and strength were evaluated along with Athlete feedback for various prototype combinations, also we did experimental activities with new materials and observe results.
Wear tests and anatomical performance tests were carried out with several different upper materials under training conditions, These were filmed and recorded for examination by the Athletes medical advisors and our designers. The outcomes of these tests altered our project R&D planning and expectation”
There is a significant degree of overlap between the Claimed Activities, and how they are described in the registration forms. All of the Claimed Activities are stated to form part of the same project, entitled ‘Delly1’ starting 1 July 2015 with an expected completion date of 30 September 2018. Each refers to the process of developing prototype shoes and testing them to obtain feedback for the development of the Delly1.
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.
The applicant contends that the development of the Delly1 included the activities and steps described in the statement of Gregory Bickley, sole director of the applicant, dated 26 August 2019 (Bickley statement). The applicant submits that the activities and steps described extended beyond simple ‘trial and error’ and involved active feedback in relation to the development of the shoe. Mr Bickley said:
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.
Annexed to the Bickley statement is a document titled ‘Delly1 Prototype Development History’ detailing each iteration of prototypes created with a description of the alleged activities and testing undertaken (Development History). The Development History shows that 6 prototypes were manufactured by PEAK. Relevant aspects of the Development History for each prototype are extracted and summarised as follows:
(a)Prototype 1 was described as, a bespoke shoe, designed as a first step in the process of designing a low-cut shoe, to meet Mr Dellavedova’s unique 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. The prototype was initially tested by Mr Bickley himself and then tested by Mr Dellavedova. The prototype was tested by Mr Dellavedova in a shootaround training session and in shooting practice and feedback was provided. The prototype was also sent to other basketball players to gauge their feedback on the design. Approximately 30 to 40 pairs were sent to players and most players trained or did a shootaround in the prototype.
(b)Prototype 2 was manufactured by PEAK in response to feedback provided about prototype 1. Testing of the prototype was to see whether the revised prototype provided additional flexibility in the upper, offered a sufficient reduction in weight and was low enough. Mr Bickley examined and tested the prototype before it was sent to Mr Dellavedova to see if the new prototype was consistent with feedback and instructions given or was in the ‘ball-park’. Mr Bickley’s testing of the prototype is described as, I walked around in the shoes but did not play basketball, as there was only one pair made, and these were to be given to Matthew. Mr Dellavedova tested the prototype during a shootaround training session. Feedback was communicated back to PEAK.
(c)Prototype 3 was manufactured by PEAK in response to feedback provided about the previous version. Changes included a new outsole, revised upper and revised heel counter. Mesh upper was included in the prototype to reduce weight and the design of the pattern was not random - it was deliberate to provide strength through minimal use of material and minimal addition of weight. There were two sub-prototypes with this version. The first with a softer mesh, then the next with a firmer and stronger mesh. The 3D printing of the KPU [mesh upper] on the lightweight mesh was critical new technology that had not been tested on a basketball shoe before. As with previous prototypes, Mr Bickley tested the prototype first. He examined the prototype and walked around in the shoes but did not play basketball, as there was only one pair made, and these were to be given to Matthew. Mr Dellavedova tested the prototype during a shootaround and light training sessions. This involved wearing the prototype while doing jump shot exercises, light ball movement drills and lots of lateral movement play. Feedback was provided by Mr Dellavedova and Mr Bickley to PEAK. In addition, photos were provided by Mr Dellavedova demonstrating peeling and stripping of the outsole. Videos provided by Mr Dellavedova showed issues he experienced with the insole, mesh, toe box and heel counter, tearing of eyelets and upper, and feedback about ankle support and the tongue.
(d)Prototype 4 was manufactured by PEAK in response to feedback provided about the previous version. Changes included a strengthened mesh and revised heel counter. As with previous prototypes, Mr Bickley tested the prototype first. He examined the prototype and walked around in the shoes but did not play basketball, as there was only one pair made, and these were to be given to Matthew. Mr Dellavedova tested the prototype during a shootaround and low intensity training and exercises. Mr Dellavedova subsequently wore the prototype at the NBA pre-season training camp. Feedback was provided from examining and wearing the prototype.
(e)Prototype 5 was manufactured by PEAK in response to feedback provided about the previous version. Changes incorporated a change to the outsole and a related modification to the heel counter. This prototype was tested by Mr Dellavedova during a shootaround, low intensity workout and then at the Milwaukee Bucks training camp. Several hand-made bespoke colour variations were produced. Prototype 5 was successful.
(f)Prototype 6 is the final prototype and production version. Due to the change in manufacturing process for production, testing was done to test the final product. Several different colour versions were manufactured by PEAK. Production runs were ordered for each colour version. Mr Dellavedova tested the production version of the prototype during NBA training and games.
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.
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.
The applicant has also provided emails from players Scott Freer dated 27 April 2023 and Damien Martin dated 28 April 2023. 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.
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.
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.
Consideration
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].
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.
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.
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.
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.
There is no evidence to establish that the outcomes of specific modifications made to the prototypes could not have been known in advance.
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].
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
In relation to section 355-25(b), the term ‘new knowledge’ is not defined by the ITAA 1997 and similarly, takes its ordinary meaning. 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’.
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.
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.
For these reasons, I am not satisfied that the Claimed Activities were conducted for the purpose of generating new knowledge.
Decision
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.
The decision under review is affirmed.
I certify that the preceding 58 (fifty-eight) paragraphs are a true copy of the reasons for the decision herein of Senior Member A Poljak
.............................[SGD]...........................................
Associate
Dated: 6 December 2023
Dates of hearing: 1 – 3 May 2023 and 21 July 2023 Counsel for the Applicant:
Solicitor for the Applicant:
Counsel for the Respondent:
Mr P Klank, Wentworth Chambers
Mr H Hope, Monotti & Hope Lawyers
Mr A Pound SC, Owen Dixon Chambers
Solicitor for the Respondent: Ms D Mak, Clayton Utz
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