MORETON RESOURCES The Full Court Decision Andrew Broadfoot QC Andrew Bailey, Victorian Bar Tax Bar Association CPD

Moreton Resources R&D Tax offset – annual registration in respect of “core activities” or “supporting activities under the Industry Research and Development Act. Innovation and Science Australia can refuse to register, or review registration once granted. Determinations of ISA bind the Commissioner of Taxation for purposes of the ITAA 1997. Reviewable in the AAT.

Core R&D Activities – ITAA 1997, s 355-25(1) Significant amendments to the definition in 2011 (prior definition was in s 73B ITAA 1936). Requirement for: 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 Based on principles of established science Proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions (b) Conducted for the purpose of generating new knowledge - includes new knowledge in the form of new or improved materials, products, devices, processes or services.

Core R&D Activities – exclusions 355-35(2) Market research, market testing etc Prospecting, exploring or drilling for minerals or petroleum for the purposes of one or more of: Discovering or determining more precisely the location of, or the size or quality of deposits Management studies or efficiency surveys Research in social science, arts or humanities Commercial, administrative and legal aspects of patenting or licensing Activities associated with complying with statutory requirements or standards, including maintaining national standards, calibrating secondary standard, routine testing and analysis of materials, components, processes, products, soils, atmospheres and other things Activity related to the reproduction of a commercial product or process Certain software development activities

Supporting activities – s 355-30 Activities “directly related to core R&D activities”. However if an activity: Is excluded from core activities under s 355-25(2); or Produces goods or services; or Is directly related to producing goods or services, the activity is a supporting activity only if it us undertaken for the dominant purpose of supporting core R&D activities.

The pilot project

Kingaroy Pilot UCG Project From 2006, Moreton planned and developed a pilot project to “test the viability of using UCG technology at the Kingaroy site to produce syngas that is then cleaned and stabilised for production of electricity using gas turbines”. Once the pilot facility objectives have been achieved and confidence in the UCG process has been gained, a larger scale plant can be built. Queensland’s February 2009 UCG Policy – the govt. would apply the strictest environmental standards to any commercial development of UCG technology.

The burn process is ignited at Kingaroy March 2010 – the burn process is ignited in Well P1 at Kilgaroy. Initial tests detect a high quality, stable syngas product. On 20 March 2010 the casing on one of the wells moves causing the well head gauge to shatter. Moreton shuts down the plant. Investigations following detect trace readings of benzene and toluene in the groundwater. DERM orders Moreton to keep the pilot project closed pending further investigations.

Kingaroy to be decommissioned and rehabilitated Moreton was never able to satisfy DERM or the Queensland govt. that groundwater resources would be protected. January 2011 – Independent Scientific Panel on UCG issue report to DERM recommending that the Moreton trial not be reignited and that Moreton move to decommission the cavity. From mid-2013, Moreton engages in rehabilitation of the site. In April 2016, Queensland govt. announces that it has decided to ban UCG in the state because of its environmental impact.

The decision of the AAT

Registration of activities and Board’s findings For the 2010 year, Moreton had applied for registration of numerous activities including design of a gas processing plant and environmental monitoring. These activities were registered. For the 2012, 2013 and 2014 years, Moreton applied for registration of activities which broadly related to rehabilitation of the site. 21 August 2015 – the Board finds (s27J IR&D Act) that the 2012, 2013 and 2014 registered activities were not “core R&D activities”. 21 December 2015 - the Board’s internal review confirms its 21 August 2015 decision. Moreton applied to the Tribunal for review of the internal review decision.

The Tribunal’s decision Considered that the notion of “experimental activities” in s355-25 did not cover activities that are conducted for the purpose of demonstrating a known fact ([187]-[188]). Stated that the purpose of the pilot project was set out in the FEED document ([255]) which noted that the requirements of the UCG process and variables were known ([257]). “I do not understand the project as described to have been undertaken to, in part, demonstrate that UCG as a process could be undertaken in an environmentally friendly manner. Rather the project was undertaken to demonstrate that UCG could occur at the particular site” ([257]).

The Tribunal’s decision The pilot project was not undertaken to develop UCG technology itself nor was it undertaken to develop any new form of pilot plant, devices or processes ([259]). Moreton’s work in undertaking the project was not experimental activity because it was not an activity that it needed to do in order to solve a problem, develop a new product or improve a process. It was testing the application of existing technology at a particular site and nothing more ([262]). Because none of the activities claimed were core R&D activities, there are no supporting R&D activities. Did not directly consider whether or not the registered activities for the 2010 year fell within the definition of “core R&D activities”.

The decision of the Full Court

Issues addressed by the Full Court Appeal from AAT requires a “question of law”. Notice of appeal raised 9 questions of law, set out at [137]. Taxpayer did not dispute that 2012-2014 year activities were excluded by reason of being “activities associated with complying with statutory requirements or standards” being conditions of environmental approvals associated with decommissioning, and rehabilitating the site and groundwater contaminated with benzene and toluene. Submission was that AAT erred in not permitting 2010 activities as “core activities”, and that 2012-2014 should be regarded as supporting.

Result – taxpayer win on statutory construction Taxpayer succeeded in establishing error by the Tribunal in relation to construction of “core R&D activities” definition. Full Court did not determine whether any of the activities were “core R&D activities” or “supporting R&D activities”. Matter was remitted to determine whether some or all of the 2010 activities were “core R&D activities” which would then enable determination of whether later year activities were “directly related” to and undertaken for the “dominant purpose” of supporting core R&D activities for 2010.

Errors made by the AAT AAT had concluded Moreton was merely testing to discover “what would be produced from the site when known technology was implemented” and Moreton was “testing the application of existing technology at a particular site and nothing more”. Consequently AAT found the activities were not “experimental”. AAT had found that on the ordinary meaning of “experimental activity”, the pilot project “can be regarded as such an activity”. Full Court at [148]: “the words ‘experimental activities’ … have little, if any, work to do” beyond describing activities that fall within paras (a) and (b)

Full Court’s construction The word “experimental” is descriptive of the types of activities that fall within paras (a) and (b). It was wrong to construe “experimental activities” as not covering activities having the purpose of generating new knowledge with respect to the application of an existing technology at a new site: at [150]-[151] “at least in circumstances such as those of the present case”. Neither the text nor context (including the extrinsic materials) supported the AAT’s construction.

Full Court further observations Emphasis given (at [153]) to the object being to encourage industry to conduct research and development that might otherwise not be conducted due to an uncertain return. The words “beneficial approach” are not used but this approach is redolent of cases such as Abbott Point Coal where Ryan and Cooper JJ said: “Whether an activity falls within the definition of ‘mining operations’ as defined in s 164-7 of the Customs Act is a question of fact.  So too is the question of when recovery is complete.  In each case a common sense and commercial approach has to be taken to the question having regard to the evident purpose of the legislation, to make rebates available to promote the exploitation of mineral deposits in Australia.”

Full court further observations Tribunal’s failure to accept that activities will be experimental activities provided that they are a test or trial undertaken for the purpose of discovering something unknown or for testing a principle is “open to doubt”. Full Court strongly indicated that the Tribunal had been wrong to not acknowledge that the pilot project would have been the first UCG facility in the world to make electricity from syngas, and mischaracterized the activities comprising the pilot project ([158]- [159]).

Implications Activities “discovering something unknown” and “testing a principle” being experimental is potentially broad – but consistent with the requirement for new knowledge in the form of “new or improved” processes, products etc. Application of existing technology in new circumstances not excluded. Full Court’s approach at [153] recognises the beneficial purpose of the legislative regime. Full Court referred compendiously to “the activities comprising the pilot project” which supports an approach that looks at related activities holistically, contrary to ISA approach which often looks at things in isolation.

Concluding Comments & Questions

Thank You Tax Bar Association Andrew Broadfoot QC Andrew Bailey