AAT Decision - Lakes Oil NL
AAT decision
On 14 April 2023, the AAT handed down its decision in Lakes Oil v Innovation and Science Australia (now Industry Innovation and Science Australia, referred to as IISA). The AAT affirmed IISA’s decision that none of Lakes Oil’s claimed activities were eligible R&D activities in the 2013-14 and 2014-15 income years.
Lakes Oil is engaged in oil and gas exploration activities in the Gippsland and Otway Basin areas in Victoria. The claimed R&D activities related to proposed fraccing (i.e. work associated with determining the potential of hydraulic fracturing to achieve commercial flow rates at certain depths).
IISA contended that the claimed activities did not meet the legislative definition of either core or supporting R&D activities under the Industry Research and Development Act 1986 (IRD Act) and the Income Tax Assessment Act 1997 (ITAA 97).
In addition, IISA contended that the activities fell within an excluded category of activities that included exploring, prospecting or drilling (section 355.25(2)(b), ITAA 97). The AAT agreed with IISA’s position and preferred IISA’s expert witness evidence over that relied on by Lakes Oil.
Case summary
The decision considers the application of the exclusion in s.355-25(2)(b) of the ITAA 97 (the exploring, prospecting or drilling exclusion). The AAT noted that 'prospecting, exploring or drilling for minerals or petroleum for the purposes of one or more of discovering deposits, determining more precisely the location of deposits, and/or determining the size or quality of deposits' is expressly excluded from the definition of “core activities”.
Lakes Oil's evidence was that its intention with Project 1 was to develop strategies to identify 'sweet spots', within the known gas field. Its expert said no exploration was needed to do this. The AAT accepted IISA’s expert evidence that 'obtaining a proper understanding of the location of sweet spots within the field was essential information that would inform any subsequent decisions about extraction, including the development of extraction methods’.
The AAT held that the Project 1 activities qualified as 'prospecting, exploring or drilling', even if they also served other purposes. The AAT held the exclusion applies and the Project 1 activities are not eligible activities.
The AAT also considered the meaning of ‘hypothesis’ in the legislative test. The AAT said it is clear that 'an hypothesis must have a scientific basis' and noted that ‘identifying the aim of the project is not the same thing as testing a hypothesis’ and 'having an aim or end in mind does not, of itself, amount to a hypothesis. It just confirms the goal was a commercial one.'
The AAT also agreed with IISA’s expert as to what a hypothesis involves, including: 'a hypothesis is more than speculative – it is a proposition which is evidence based – it must be substantiated. There must be material pointing towards a hypothesis that can provide a basis for the proposition which is then tested' and 'a hypothesis cannot be verified prior to experimentation.'
The AAT found that in this case, 'there was no evidence of any scientific basis behind the hypotheses. Rather, Lakes Oil knew the best return on investment would occur if it could frac a half-length of 100m. This is not a hypothesis.'
The AAT also considered the importance and utility of evidence from a competent professional in the field when considering whether the outcome of the activities could have been known or determined in advance or whether they could only be determined through the application of a systematic progression of work based on principles of established science.
The AAT commented that, 'It is uncontroversial that whether an outcome can only be determined through the application of systematic progression of work based on scientific principles involves an objective determination from the perspective of a competent professional in the field.'
As to the meaning of ‘new knowledge’ in the legislative test the AAT said, 'What is meant by “new knowledge”? The term “new knowledge” is not defined in the Act and therefore the ordinary meaning should be applied. The phrase “new knowledge” is found within the section concerned with experiments being conducted where the outcome could not be known in advance by a competent professional in the field… On that basis, it is reasonable to conclude “new knowledge” means not previously known by a competent professional in the field.'
How this affects your business
This AAT decision confirms that the legislative test requires claimed activities to be conducted in a scientific way and that a valid hypothesis (which must have a scientific basis) is an important starting point in determining whether the claimed activities are experimental activities satisfying each criteria of the legislative test for eligibility. The importance of contemporaneous documentation to support claims for the R&D is also reinforced by this AAT decision.
IISA’s response
The legislative test for eligibility also requires claimed activities to be conducted in a scientific way and the activities must proceed from a valid hypothesis (which must have a scientific basis).
Evidence from a competent professional in the field assists to determine whether the outcome of the claimed activities can only be determined through the application of a systematic progression of work based on principles of established science.
It is also important that companies keep contemporaneous documentation, which are documents from around the time of their activities, to support their claims for the R&D.
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