There has been great excitement amongst the R&D tax relief advisory community since the publication of the First Tier Tax Tribunal`s judgment in the case of Get Onbord Limited (in liquidation) v The Commissioners for His Majesty`s Revenue and Customs (2004) UKFTT 617 (TC) on 9th July 2024.
The R&D advance was in the field of software/computer science/AI and the case is being held out as being of principal benefit to those companies making claims for advances in these fields of science and technology. There are, however, far-reaching ramifications beyond this. The case demonstrates flaws in HMRC`s current compliance approach and provides some reassurance and optimism to companies involved in other areas of R&D that their claims are valid and can be defended.
The issues to be determined
The tribunal had to determine whether the evidence provided by a former director was admissible, as the company had gone into liquidation and the director had no authority to act once the liquidator had been appointed. The principal issues, however, that the judge had to decide on are very familiar to those of us involved in dealing with R&D tax relief compliance checks under the current regime employed by the Individual & Small Business Compliance Unit:
Whether the competent professional was competent in the relevant area of science/technology sought to be advanced;
Whether the project activity truly sought an advance in the overall field of science/technology;
Whether the scientific/technical challenges went beyond what might be regarded as routine.
The claim was submitted in March 2021 and the compliance check opened in May 2021; at a time when HMRC had deployed huge numbers of new caseworkers into the Individual & Small Business Compliance Unit to increase the numbers of compliance checks into claims made by SMEs. This increase in compliance activity was due to HMRC suspecting SMEs of abusing the scheme by submitting fraudulent, exaggerated or inaccurate claims.
The compliance check was, as per current practice, conducted by correspondence and without any face-to-face meetings. Get Onbord answered HMRC`s technical questions extensively and offered twice to meet with HMRC`s caseworkers to answer questions in person and explain the nature of the advance sought but, in typical HMRC fashion, it refused all meeting requests.
According to HMRC, the claim had been referred to its Chief Digital Information Officers who considered that the project did not qualify as R&D. The reasoning was that there was no evidence that Get Onbord had sought to achieve an advance. HMRC stated “The use of the APIs, AI, algorithms, the data manipulation and database design may have been novel and difficult to achieve, however, we have had no evidence that there has been an advance to any technologies in the process.”
When the case came to the tribunal, HMRC sent the HMRC officer responsible for the case, Mr Umar, to give evidence. Although a member of HMRC`s software team, Mr Umar had no technology experience or expertise and he was not aware of the credentials of his colleagues in the digital information team that had commented on the validity of the R&D when the matter had been referred to them for advice.
This was the first software claim that Mr Umar had been involved with. Although an honest witness, the judge found him to be of no assistance in helping him to resolve the scientific/technical issues that he needed to resolve. The tribunal had no choice but to prefer the evidence of Mr Cahill, for Get Onbord, and find that the project activity did satisfy the tax definition of R&D.
The judgment is a victory not just for Get Onbord but for all other companies and their advisors who are struggling to overcome HMRC`s unwillingness to accept any claims selected for enquiry as satisfying the tax definition of R&D. It is reassuring to see that in this case, Get Onbord experienced much of the negativity and formulaic responses from HMRC throughout the compliance check, which other SMEs currently receive such as “the project activity involved the routine copying or adaptation of existing technology” and “the work just benefits the company alone rather than being an advance in the overall field of technology”. It is pleasing that at the end of the day, the FTT adopted a far more balanced view than HMRC`s R&D team and did not start from a presumption that the claimant company did not qualify for R&D tax relief, which sadly seems to be the approach taken by HMRC.
What`s next?
This tribunal decision has, understandably, given rise to flickers of optimism for those working in R&D tax relief and companies dealing with HMRC compliance checks who will now wonder whether HMRC will alter its behaviour during compliance checks and be more reasonable when considering the validity of the claims put forward. It is well reported that it is the practice of HMRC`s Individual & Small Business Compliance Unit to find any way of resolutely denying a claim for R&D tax relief irrespective of the arguments and evidence put forward to defend the claim. It has become somewhat of a “lottery” as to whether a company is lucky enough to be one of the nineteen companies out of every twenty that avoids receiving notice of a compliance check.
Indeed, the last two years have been a nightmare for many SMEs, forced to jump through endless hoops to defend claims only to be told that they don`t qualify by an unidentified HMRC caseworker, often by reference to the results of Google searches.
There is no doubt that the R&D tax relief “industry” needed a massive shake-up to improve compliance and weed-out the R&D cowboys. There was, historically, a widespread, and misguided notion, that Government support for R&D activity meant automatic pay-outs for companies carrying out any kind of technical problem-solving rather than genuine innovation. Sales slogans promising free money, a risk-free claims process and requiring no work to be carried out by claiming companies themselves were dangerous and plainly, ridiculous.
HMRC`s current compliance approach is designed to clean up the R&D tax relief industry. Whilst meritorious and necessary, it has been fraught with problems. The volume, formulaic and heavily process-driven new compliance approach adopted by the Individual and Small Business Compliance Unit, in particular, has resulted in companies carrying out genuine R&D activity being denied relief for R&D projects because companies and advisers are unable to persuade HMRC of the validity of their claims, no matter how well-articulated their answers to HMRC questions may be. Worn down by the process, many genuine claimants have been forced to abandon their claims for R&D tax relief and accept HMRC`s opinion that their project does not qualify as R&D.
This is, of course, an extremely sad state of affairs for the companies concerned and for the U.K. economy. Companies with valid R&D projects who have had to endure an arduous and ultimately unsuccessful compliance process will, inevitably, not claim in the future. This causes financial constraints for the companies in being denied income which might have been relied upon to stimulate further innovation and business growth. It has additional, wide-reaching impacts, as it is resulting in companies lacking confidence in bringing claims for R&D tax relief and at worst, deciding not to continue carrying out R&D at all or else moving overseas to do so.
This is, of course, not what the Government says that it wants. Encouraging companies to carry out R&D is part of its Growth Agenda. It is clear, however, that HMRC`s current compliance approach requires review and an overhaul. We wonder whether this decision will be the catalyst for change.
What changes are needed?
We suspect that it will take a couple more Tribunal decisions in favour of corporate taxpayers on the subject matter of the tax definition of R&D, the evidence required to prove it and criticising HMRC`s approach before HMRC considers making changes to its internal compliance process.
Certainly, to improve taxpayer confidence in the R&D tax relief compliance process, improvements need to be made to HMRC`s risk criteria in terms of identifying the most appropriate claims to enquire into. Any criteria that focuses solely on claim value or industry is unreliable.
Consideration might be given to introducing a questionnaire to be completed by claiming companies at the same time as filing the Additional Information Form. This could include questions to investigate the competency of the competent professionals and questions to investigate the research carried out by a claiming company to investigate the baseline position in science/technology which it sought to advance, before the R&D activity commenced.
Reforms might also include the preparation and delivery of a pack of supporting evidence to be supplied to HMRC to evidence the advance, the scientific/technical uncertainties identified and the costs incurred. The criteria for selecting claims for enquiry could focus on where a company is unable to offer any evidence in support of the R&D project.
Secondly, changes need to be made to the compliance approach adopted by HMRC`s Individual & Small Business Compliance Unit. These need to include abolishing templated letters and requiring any letter sent to be individualised and appropriate to the claim. A named inspector or caseworker needs to be assigned to each claim with a business telephone number and email address provided to facilitate contact between HMRC and the taxpayer. The current paper-based correspondence approach should also be abolished in favour of face-to-face meetings or Teams/Zoom meetings.
Further, challenges to the opinion of competent professionals by HMRC caseworkers on the basis of internet searches need to be abolished. Certainly, on the basis of the decision in Get Onbord, if a company involved in a current compliance check is experiencing a HMRC caseworker doubting the opinion expressed by its competent professional and is citing the results of Google searches instead, the company concerned needs to push back, refuse to accept the opinion of the caseworker and remind him/her as to the likely outcome if the case went to tribunal. As a matter of common sense, a judge will not prefer the evidence of a HMRC caseworker over a competent professional who can demonstrate current knowledge and skills and experience in the field and where the caseworker has no such experience or knowledge.
Further, if a caseworker has serious doubts about the validity of an opinion stated by the company`s competent professional on the issue of the baseline position in a field of science/technology, consideration ought to be given to the appointment of a jointly appointed competent professional to comment.
Conclusion
We know that HMRC is experiencing a substantial backlog in the Individual & Small Business Compliance Unit processing of appeals against R&D enquiry closure notices with delays also experienced in the Solicitor review team. The delays are due to the huge number of companies dissatisfied with the compliance approach currently adopted by HMRC and a strong desire to defend their claims for R&D tax relief.
We suspect that the decision in Get Onbord will be followed by many others where the issues to be decided are similar. Whilst there is no doubt that there was an urgent need for the Government, and HMRC, to take steps to reform the R&D tax relief schemes, to include enquiring into more R&D tax relief claims with the aim of improving standards and stamping out fraud and abuse, the approach taken by the Individual & Small Business Compliance Unit to date has not been helpful and has resulted in many corporate taxpayers losing confidence in the R&D tax relief system. We do hope that over time, we are able to move back to a more personal, individualised approach to tackling R&D tax relief compliance, where the process is shortened, and all parties are reassured that the process is fair and that the correct decision is made.
