23 September 2024

Get Onbord & Tills Plus: some encouragement for taxpayers – Tax Journal article

Thomas Chacko’s recent article for Tax Journal looks at recent cases on HMRC’s threshold for research and development claims.

HMRC have become increasingly reluctant to approve research and development claims. The recent cases of Get Onbord v HMRC and Tills Plus v HMRC provide some support for taxpayers: both suggesting that HMRC’s threshold for approving research may be too high and making clear that HMRC need to explain why a project does not qualify if the taxpayer has made a serious case for why it does. Early preparation for these disputes is key. The right witnesses need to be before the tribunal in order to explain the technical difficulties clearly.

Two recent FTT decisions on research and development (R&D) allowances – Get Onbord Ltd (in liquidation) v HMRC [2024] UKFTT 617 and Tills Plus v HMRC [2024] UKFTT 614 – hopefully show a greater level of realism about the difficulties for taxpayers in demonstrating their eligibility. They are also useful guides to how evidence to support R&D claims should be gathered and presented.

Research and development

R&D allowances are provided for in CTA 2009 Part 13. CTA 2009 s 1041 applies the meaning of ‘research and development’ used in CTA 2010 s 1138, which itself applies the definition in ITA 2007 s 1006, which allows the Treasury to specify the activities which are to be treated as research and development. The Research and Development (Prescribed Activities) Regulations, SI 2004/712, state that research and development activities are to be those set out in the Guidelines on the meaning of research and development for tax purposes issued by the Secretary of State for Trade and Industry (the ‘BEIS Guidelines’) on 5 March 2004. These were reissued in 2010 and most recently updated in March 2023.

Under the BEIS Guidelines, R&D projects are those which seek to ‘achieve an advance in science or technology’, which involves resolving ‘scientific or technological uncertainty’. According to para 6, an ‘advance in science or technology’ means an advance in ‘overall knowledge or capability in a field of science or technology’, as compared to simply advancing the capabilities of the taxpayer.

Thus far, the definition seems to place a very high hurdle on the tax relief, suggesting that it only applies if a business is cutting new ground, driving a field forward significantly. However, the Guidelines go on to tone that down very substantially. For example, para 9 states:

‘9. A project which seeks to, for example,

(a)     extend overall knowledge or capability in a field of science or technology; or

(b)     create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or

(c)     make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or

(d)     use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way (e.g. a product which has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner) will therefore be R&D.’

And para 11: ‘If a particular advance in science or technology has already been made or attempted but details are not readily available (for example, if it is a trade secret), work to achieve such an advance can still be an advance in science or technology.’

This is to be contrasted with para 12, ‘the routine analysis, copying or adaptation of an existing product, process, service or material‘, which does not qualify.

The definition of ‘scientific or technological uncertainty‘ in paras 13 and 14, and the definition of ‘overall knowledge and capability‘ in paras 20 and 21, also move away significantly from the very high-level statements in para 6:

’13. Scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice, is not readily available or deducible by a competent professional working in the field. This includes system uncertainty. Scientific or technological uncertainty will often arise from turning something that has already been established as scientifically feasible into a cost-effective, reliable and reproducible process, material, device, product or service.

’14. Uncertainties that can readily be resolved by a competent professional working in the field are not scientific or technological uncertainties. Similarly, improvements, optimisations and fine-tuning which do not materially affect the underlying science or technology do not constitute work to resolve scientific or technological uncertainty.

…

’20. Overall knowledge or capability in a field of science or technology means the knowledge or capability in the field which is publicly available or is readily deducible from the publicly available knowledge or capability by a competent professional working in the field. Work which seeks an advance relative to this overall knowledge or capability is R&D.

’21. Overall knowledge or capability in a field of science or technology can still be advanced (and hence R&D can still be done) in situations where:

• • several companies are working at the cutting edge in the same field, and are doing similar work independently; or
  • work has already been done but this is not known in general because it is a trade secret, and another company repeats the work; or
  • it is known that a particular advance in science or technology has been achieved, but the details of how are not readily available.

’22. However, the routine analysis, copying or adaptation of an existing process, material, device, product or service will not advance overall knowledge or capability, even though it may be completely new to the company or the company’s trade.’

The effect of this is that, even though para 6 appears to require work that moves forward the boundaries of a field of science, qualifying R&D is intended to encompass replication of someone else’s trade secret, or work on improvements that are not ‘routine’ or ‘readily deducible’ by a competent professional. This is reinforced in the definition in paras 23–25 of ‘appreciable improvement’ as ‘something that would generally be acknowledged by a competent professional working in the field as a genuine and non-trivial improvement.’ It can also include resolving the uncertainties involved in combining existing technologies and systems in a novel way (defined as ‘system uncertainty’).

HMRC’s current approach

HMRC has become much more reluctant to approve R&D claims in recent years. This is partly because they have been faced with large numbers of hopeless claims: small businesses that were very unlikely to be engaged in research and development, such as scaffolders or plumbers, who had been encouraged to put in claims that, historically, HMRC might process and pay out on before investigating.

However, this reluctance has also extended to what are clearly serious development projects, and the complaint from many advisers is not just that HMRC refuse claims, but that it is very difficult to get HMRC to explain why they believe a project is not qualifying R&D.

It is true that the legislation sets HMRC (and advisers) a very difficult task: deciding whether an activity qualifies involves knowing what the current state of the field of science or technology is, what products, processes or services would or would not be within the reasonable capabilities of a competent professional, and what sorts of improvements would be seen as trivial or non-trivial. Approaching these strictly, one would expect disputes to turn on expert evidence about the state of knowledge in a particular field: but frequently the amounts claimed are far too small to justify litigation on that scale.

The fact that a project involves a lot of time from a lot of experts does not necessarily mean it solves any unsolved problems: as explained in Hadee Engineering v HMRC [2020] UKFTT 497 at [139], building a bridge across difficult terrain may involve a lot of engineering work, but possibly no new research. Software presents particular difficulties because the distinction between employing competent software developers to apply existing knowledge to create a new product, or to solve unsolved problems in order to create that product, is going to be very hard to explain.

However, it does seem (from my professional experience and the reported cases) that HMRC generally place the threshold too high: focusing on para 6 and its reference to an advance in science or technology rather than considering the rest of the guidelines, which point to improvements which only need to be more than ‘trivial’ or something that a professional would see as more than ‘routine’, to ‘system uncertainty’, or to the examples, which include making a slightly improved DVD player (Example A1).

Get Onbord

This issue was dealt with directly in Get Onbord. The taxpayer’s project was an automated and AI-enabled process for KYC verification. They explained that there was no existing technology that provided this function, and that it presented various difficulties, such as finding a way (without human involvement) to uniquely and accurately track individuals so that information from multiple sources could be combined, in such a way that this would be faster than existing KYC systems.

HMRC maintained this was not R&D. However, they did not (at least as recorded by the tribunal at [70]) really engage with the detail of what Get Onbord were trying to do: rather, they argued that creating a new function was not itself R&D, that an ‘appreciable improvement’ was not sufficient unless it also involved an advance in the underlying science or technology, and that having developed unique functions and coding could not be sufficient because almost all software development involves unique code. Beyond that, they seem simply to have relied on the burden of proof and argued that Get Onbord had not shown that their work was sufficiently novel.

There was also an unusual procedural issue: it transpired after the hearing that Get Onbord was in Iiquidation, and that the liquidators were unaware of the hearing and had not authorised the director to make submissions on behalf of the company. HMRC argued that the hearing needed to be repeated, but the tribunal decided it could allow the liquidators to adopt (retrospectively) the submissions made by the director.

In terms of the threshold for R&D, as recorded at [70], HMRC asked the tribunal to read the parts of the Guidelines that appeared to allow more nuanced improvements in capability (such as the passages on ‘appreciable improvement‘) as subject to paragraph 6: while making an ‘appreciable improvement‘ may qualify, this will only be the case ‘where an appreciable improvement is brought about by some advancement to the underlying science or technology‘. This seems to imply that even though the Guidelines seem to say that making improvements will be R&D if they are more than trivial, this is only permitted if the way that those non-trivial improvements are effected is by driving forward the frontiers of science. This sits very awkwardly both with the bulk of the Guidelines (almost all of them apart from para 6) and with the examples: there is no suggestion that the improvements to the DVD player in Example A1 required some discovery in the general field of optics.

This was rejected by the tribunal: as set out at [92]–[95], if a new function had been created, using massive amounts of new code that went beyond routine adaptation, it was not required that the taxpayer show that the component parts of their solution were themselves novel or bespoke: ‘if complete novelty were the test, no software project would ever amount to R&D.’

This feels very different to Hadee Engineering, where at [239] the tribunal adopted the observations in BE Studios v Smith and Williamson [2005] EWHC (Ch) 1506, a negligence case, that (among other things), ‘R&D is thus characterised by work which breaks new ground’. Notably, that passage in BE Studios is quoting the 2000 DTI guidelines, which were replaced by the current BEIS Guidelines. The current guidelines do not make any reference to ‘breaking new ground‘.

This is an important point and it is helpful that the tribunal has recognised it: HMRC’s focus on advancing a field of science would imply that R&D allowances were almost never available. This is a relief designed for SMEs, and an interpretation that makes it unlikely for any qualifying activity to take place outside the tech giants and universities seems implausible.

The other important aspect of Get Onbord is the approach to the evidence. HMRC had relied heavily on the burden of proof, saying that the taxpayer needed to show that there had been an advance in science or technology. The tribunal agreed that the general burden was on the taxpayer, but held (see in particular [77] and [96]) that the taxpayer had demonstrated enough to shift the burden back onto HMRC. The taxpayer having shown that they were working on a product that was not available in the market, that required the attention of a large number of specialist professionals, and which appeared to be dealing with problems that were not yet solved, HMRC needed to explain why this did not qualify: if this was mere routine adaptation, within the ordinary knowledge of competent professionals, then HMRC should have presented evidence of that.

Tills Plus

There is further support for this in the more recent decision of Tills Plus. The tribunal were ready to accept that a report on proposed works, which appeared to involve genuine advances in capability, would have constituted R&D ‘in the absence of any evidence from HMRC‘ challenging the contents of that report (Tills Plus at [148]). However, the tribunal found that the report did not in fact represent the work that Tills Plus had paid for, and the claim was refused.

Tills Plus also dealt with where the taxpayer had ‘made a sub-contractor payment‘ where a third party had paid the subcontractor on the basis that the taxpayer would then be indebted to that third party: the FTT decided that this did count as payment.

While this situation (partly arising because of difficulties in sending money to or from Iran) may be unusual, in dealing with it the tribunal discussed the significance of a passage of Henderson J (as he then was) in Gripple v HMRC [2010] EWHC 1609, which is often cited in R&D cases as authority that the BEIS guidelines are a prescriptive code that is not susceptible to purposive interpretation. The FTT were critical of this: Henderson J was rejecting an argument that the rules in terms of who was supposed to have paid for the R&D could be ignored in favour of a very high level interpretation that relief should be available if R&D had taken place, rather than suggesting that the R&D regime was an island immune to purposive construction. As they went on to observe, even if that were the meaning of Gripple it is not something that would have survived the last 14 years of Ramsay authorities.

Conclusion and recommendations

These two cases show a helpful realism on the part of the tribunal about what a taxpayer can be expected to show, particularly where the amounts at stake are not huge and where HMRC have not really explained why they say that no research is taking place. Get Onbord pushes back against the tendency for HMRC to argue that R&D can only be happening if the frontiers of science are being pushed back in some clear way. Hopefully the comments about ‘breaking new ground’ in BE Studios and the suggestion that purposive construction has no role in the BEIS Guidelines, often attributed to Gripple, will now be recognised as superseded.

However, the approach to evidence in Get Onbord will only be helpful to those taxpayers who have put forward clear evidence of how what they are doing is a genuine advancement or improvement. As in Tills Plus, many R&D appeals are lost because the taxpayer has not put forward sufficient evidence to explain what it was that they were doing, or has not called witnesses who can explain the research to the tribunal.

To prepare for an R&D dispute, it is important to get the right people involved at an early stage: the people who understand what is difficult and novel about a research project. This may not always be the person in charge: that person may have a clear idea about what the project is trying to achieve, but may not have sufficient understanding of the tasks and problems involved.

It is worth doing this well before the dispute reaches litigation. While it can be difficult to persuade a busy client that their research staff need to spend significant amounts of time discussing their work with tax advisors in the early stages of an HMRC enquiry, doing this early may head off litigation. While HMRC are unlikely to be persuaded by a high-level summary that does not get to grips with the actual uncertainties involved, they may be more receptive to correspondence that goes into detail about the precise difficulties encountered and resolved. This also flags up to HMRC that this is a serious claim that may be taken to tribunal.

Explaining the material to HMRC will be difficult because the people working on the project, if it is qualifying R&D, will be subject experts who may not be used to explaining what they do to people who have no experience of it. The correspondence with HMRC will be more laborious than in many other enquiries: in most tax disputes, the HMRC inspector will have experience of the tax issue being argued about, and this means that quite a general explanation of the taxpayer’s position will still be understood and it should quickly be possible to narrow the areas of dispute to the real issues. With R&D claims, the inspector may have no previous knowledge of the field that is being explained.

This means it is important to be patient: advisers will know this but the client, who won’t be familiar with the process, may get very frustrated if letters may come back with questions that the client thinks they have already answered. They need to be answered carefully, even if it is repetitive. If HMRC ask 15 questions that seem to overlap, it is still worth answering all 15 in full.

Irrespective of whether HMRC’s threshold for approving R&D is too high, R&D cases have so far typically been lost where a taxpayer has not put forward their evidence properly. Given the complexity of the material, this is not something that can easily be solved in the run up to a hearing. In these cases early evidence gathering is key.

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For related reading visit taxjournal.com

• Other cases that caught our eye (Get Onbord Ltd & Tills Plus, 24.7.24)
• Planning for the merged R&D regime (C Rutland & J Rolfe, 14.2.24)
• How to handle R&D enquiries (H Adams & C Rutland, 26.7.23)
• News: Valid R&D claims still being rejected, says CIOT (13.12.23)
• Cases: Hadee Engineering Ltd v HMRC (20.1.21)