Tax Tribunal cases involving R&D tax relief have historically been few and far between. Then 2020 happened and, in case you’re thinking that the year couldn't get any more unusual, we were thrown two R&D cases within 5 months of each other.
The first, HMRC vs. AHK Recruitment (released in May 2020), contained a load of useful information about what R&D advisors should do and, perhaps more importantly, shouldn’t do. Our thinking on that case and its impact on the R&D advice world is found here.
Then a further case, HMRC vs. Hadee Engineering Co Limited (released on 10 October) contains similar levels of advice, but mainly levelled at the company making the R&D tax relief claim.
We have reproduced the salient facts of each of these cases below.
Background
The company made claims for the periods ended 30 April 2009 and 2010, claiming qualifying expenditure of approximately £400,000 across the two periods, using a third party R&D advisor to support it.
The claims were filed with HMRC in time – albeit not with the original filing of the corporation tax returns; indeed, the revised tax return including the 2009 claim was filed just 10 days ahead of the final deadline for that claim, and the report substantiating the claim filed 6 days after that.
HMRC enquired into the claim in February 2012; nearly 10 months from the filing of the R&D claims and less than 3 months from the latest date they were able to (save for situations involving accusations of serious malpractice).
As we see all too often, a back-and-forth ensued between the claimant company, HMRC and the R&D advisor. These responses can generally be described as ranging between partial and unhelpful, which risks testing the patience of HMRC (never a good idea when you’re trying to get them to agree your claim).
The upshot of this communication led, nearly 6 years from the original enquiry, to HMRC issuing closure notices for the accounting periods under review denying the claims in full. The company, not agreeing with this outcome, appealed and took the case to the First Tier Tribunal.
The Outcome
Cutting straight to the chase, the Tribunal threw out almost the entire claim.
Read on to find out why…
The Tribunal
In a parallel with HMRC vs. AHK Recruitment, they didn’t outright dispute that the company actually did R&D (although it isn’t a big leap to infer that’s their view from reading the proceedings in isolation). In fact, the Tribunal allowed some activities as eligible that HMRC had previously denied on enquiry.
However, their position was that the evidence the company produced – both at Tribunal and throughout the enquiry – failed to adequately demonstrate (for the most part) that what they were doing was R&D.
The claimant took the view that they were the competent professional and, because they (as competent professional) said it was R&D, it was up to HMRC to prove that it wasn’t.
This combative viewpoint is not only likely to ruffle some feathers at HMRC but is simply incorrect. HMRC, as initial arbiters in R&D tax relief claims, have a duty to investigate claims and scrutinise whether they stand up to the rules that govern the regime.
They don’t need to be subject matter experts in any particular area of technology. No more so than I, an experienced R&D professional, need to be. Sure, my background’s really helpful when it comes to facilitating conversations with engineering staff but my experience of the scheme and how it works is just as important, if not even more so.
As a facile example, imagine explaining how a toaster works to an alien. You’d likely start by saying that it’s a device you put bread in, that gets hot and causes the external surface of the bread to become warm and crunchy. You might even, if they were really interested in it, tell them that the heat was generated by the wires seen on the insides of the toaster. If you’re particularly technically minded, you might even delve as far as how the heat is a biproduct of the resistance of those wires to the flow of electrical energy through them. What you’d be unlikely to say (if you were trying to make friends) is “because I said so”, before announcing that if they had any questions, they’d need to employ their own toast-based specialist to address these before ultimately agreeing that you were right all along.
In general, HMRC trust the claimant themselves to be that specialist. Just to spell out how generous that is, it’s akin to a claimant being its own judge and jury. The guidelines even have a grandiose term for it; the “competent professional”. This is a person who has the background, skills and experience to say what is and isn’t possible within the industry. To expect HMRC to simply believe them and demand that they either not ask questions or spend taxpayer money on hiring their own specialist to create a situation of one word against another is unreasonable. They have (and should have) the right to ask questions of the competent professional to make sure that this assessment has been made on the right basis.
HMRC’s starting point when reviewing a claim is (and should be) two things:
1) Do the activities being claimed actually count as R&D?
2) Do the costs being claimed fall in allowable categories of spend?
When it comes to the technical side of the claim – i.e. why the activities being claimed qualify as R&D – I’m not giving away any of Cooper Parry’s IP when I divulge that it’s important to evidence the specific advance that’s being sought by any project. Or that some idea of what the background level of capability in an industry was before the project started. It’s also pretty vital to be able to describe, in reasonable detail, the work that was done by the company making the claim in order to resolve the challenges inherent within it.
The costing side is even more clear-cut. It’s an often used criticism by tax professionals that they’ve got over 22,000 pages of legislation to read, which spans a number of books guaranteed to impress any visitor to your house (if they’re allowed), whereas the full-time R&D advisors’ job is based around 50 pages of legislation. If a cost of a qualifying activity can be shown to belong in one of the qualifying categories, it’s in. If it’s not, it’s out. Simple as that.
When it comes to this case, HMRC’s initial enquiry resulted from them not being assured that the activities had been considered thoroughly enough. Rather than produce additional documentation, the claimant and the advisor both appeared to point HMRC at the other for what was needed.
Then – several rounds of correspondence and nearly 6 years later – HMRC decided that it had asked enough times for this evidence and issued closure notices denying the claims.
The Reasoning
At Tribunal, the claimant’s evidence largely fell into one (or more) of four buckets. It either:
1) Restated what was said before;
2) Conflicted with what had been previously said to HMRC;
3) Was new to HMRC (and which may have been useful had it been provided earlier in the process); and/or
4) Could not be evidenced by any means except taking the claimant’s word, as no records existed.
The first of these was unhelpful to the claimant’s case, and the second served only to undermine their credibility – so much so in fact, that their ability to be defined as the ‘competent professional’ was called into question at one point.
I can feel HMRC’s frustration on the third point. Having asked a number of times for additional information – to be told it didn’t exist – only for some to be presented at Tribunal must have had them pulling their hair out.
However, the nail in the metaphorical coffin for this case was definitely point 3. Records weren’t kept, either at all or at least not to a standard that allowed the claim to appear robust. Project numbers were sometimes used on documentation but not always, and most projects appeared to be based on ‘informal requests’ for work to be performed rather than being set down in contract.
The trouble with that is, when it comes to evidencing what the arrangements were (several years later and in defence of a claim at Tribunal), an answer that happens to generate the best outcome for an R&D claim at least appears suspiciously coincidental.
Most of the projects being claimed were done so as the claimant’s own R&D. The story typically went like this:
1) Customer can’t achieve a particular outcome themselves (either don’t have the skillset or time).
2) Customer approached claimant to provide solution
3) Claimant undertakes work to produce solution
4) Customer buys solution
However, without evidence to the contrary, it’s not a difficult leap to agree to points 1 and 2, but see points 3 and 4 become:
3) Claimant undertakes developmental work for customer
4) Customer pays claimant for the work involved
That leap is even easier to make when, following investigation by HMRC, a box full of invoices appear that show recharges from the claimant to its customers for the projects.
The problem with this recharge for the claimant is that it has a material (and bad) impact on the R&D claim. Where a customer is getting recharged by the claimant for the development work it suggests that the work is either:
- Subcontracted-in R&D – which, as an SME, is only claimable if it’s from an entity that’s not itself an SME; or
- Subsidised R&D – which, as an SME, means that claims for the subsidised part are available only under the large company R&D scheme (which today offers relief at approximately one third of the SME rate).
Without a contract to rely on that spells out who is responsible for what, and what is going to be paid (and for what), asking HMRC / the Tribunal to believe the situation that just coincidentally happens to provide the best outcome for the client is pretty unreasonable, especially after 6 years of asking.
Even wearers of the rosiest of rose-tinted glasses are likely to have any remaining faith in that coincidence shaken further by the claimant including salary and bonus costs that were nearly 4 times what was disclosed in the accounts. And being able to offer no evidence that the costs of consumables being included were actually paid in the period that they were claimed for underlines that still further.
The Impact
My apparent viewpoint of “it’s all the claimant’s fault” might seem harsh to some (particularly to my own clients!). After all, they engaged a specialist R&D advisor to undertake their claim. Surely some fault lies at their door rather than wholly at the claimant?
I’m sympathetic to a certain extent – the advisor in question “declined to assist with HMRC’s queries” in the defence of their own claim. I can’t think of a single reason where we as a firm would refuse to help a client with an enquiry into a claim that someone from the team had a hand in putting together. Put simply, if we didn’t believe in the claim value, we wouldn’t recommend its filing and wouldn’t provide claim value and a report to the client. On the other hand, if we did believe in it, we’d be prepared to argue it as far as necessary (and would make sure the claimant had the evidence to back it up).
It also appears that the claim produced could have had its tyres kicked a little more thoroughly than it was – things like claiming more cost than appears in the accounts is a fairly fundamental error and one which an experienced practitioner would be expected to pick up. Instead, the claim was passed to the claimant by the R&D advisor with the caveats that they “had not verified the information and that the appellant was ultimately responsible for it”.
It’s hard to tell from the judgement alone what relationship the claimant and advisor had. My clients, without exception, are pretty accepting of my challenges to their claim or their records, as they know I’m doing it in the best interests of their claim, and to save them the pain of a protracted HMRC enquiry.
However, some clients can be pretty challenging to work with; they don’t provide very good information and/or provide it at the eleventh hour. They allude to the fact that the information exists somewhere and that they’ll provide it but, with limited time available, it becomes a straight choice between telling them you’ll use their numbers (but they’ll have to agree the claim is entirely at their risk) and walking away from the claim (which may open you up to a lawsuit for an unfiled claim if the client is particularly litigious).
Thankfully for the R&D practitioner, those situations are rare. But when they do arise, the right answer is always to walk away. To do otherwise risks your integrity and the reputation of you and your firm. It also preserves the increasingly-fragile reputation of the R&D scheme; it’s taken enough of a kicking recently.
The Takeaway
Regardless of the state of the relationship between R&D advisor and client, the biggest problem in this case was always record keeping. Records either never existed, were destroyed (despite the claim being under enquiry and therefore there being an obligation to preserve records), or were lost in an alleged fire at a point between the enquiry being opened and the Tribunal.
Great as we are (and we are), we can’t work miracles; we need our clients to keep enough of a record so that there’s evidence of what’s been done, who it’s been done by, what’s been paid and what’s been received. Otherwise it’s like giving us a jigsaw puzzle with only half the pieces, but still expecting to get the full picture when we’re done.
