The R&D tax case we’ve been waiting for? HMRC loses at the First Tier Tribunal
Many readers will be aware of the turbulence within the R&D tax relief sector in recent years. HMRC’s hard-line stance during compliance checks has left many claimant companies bewildered that their claims have been rejected, with decisions often based on flimsy, ill-conceived justifications.
For months, advisers have been waiting for a high-quality test case to reach the First Tier Tribunal (FTT). Whilst there have been several FTT cases involving R&D tax relief over the past two years, there has been an absence of robust cases which would adequately test HMRC’s baseless policing of what constitutes qualifying R&D for tax purposes.
That has now changed.
On 9th July, a judgement was made involving Get Onbord Limited (GOL). The company made a claim for R&D tax relief, with details of the R&D undertaken submitted to HMRC in August 2021. The single project forming the claim was the development of a novel, automated artificial intelligence (AI) analysis process for know-your-client (KYC) verification and risk profiling. The system, known as ONBORD, would achieve a superior outcome to human analysis and meet all regulatory and legislative requirements. It was stated in the report that:
‘the Company considered that the development of the ONBORD system constituted an appreciable improvement in the technology associated with AI for KYC analysis. The development of the ONBORD system contained significant technical uncertainties, involving knowledge that could not be readily deduced by the Company’s competent professionals’.
On 15th September 2021, HMRC wrote to GOL and the company’s adviser, Myriad Associates, explaining that they did not view the project as qualifying R&D. Myriad Associates duly responded, outlining in further detail why the project met the BEIS 2004 Guidelines. On 12 November 2021 HMRC replied, describing GOL’s project in glowing terms (“a complex platform … the project took a lot of hard work and dedication … impressive”), but indicating that (despite all the information Myriad provided) they were “still unclear as to what advance has been achieved.
Later in the case, HMRC responded ‘We have taken the time and have carefully gone through your response which we received from yourselves along with using our CDIO officers, who are HMRC’s Chief Digital Information Officers.’ Their conclusion was that no R&D had taken place. No reasons were given for that view. By 14th October 2022 (i.e. over a year since the compliance check was opened), HMRC issued their review conclusion letter, upholding the view that the project did not constitute qualifying R&D for tax purposes.
Readers will know from the title of the article that the FTT ruled in favour of the claimant company. It was accepted by the Tribunal that qualifying R&D had taken place. However, and more importantly, the Tribunal issued a number of statements that are likely to have serious consequences for HMRC’s current approach to R&D tax relief.
The Burden of Proof
HMRC routinely remind claimant companies during compliance checks that the burden of proof is with the claimant company to show that an advance in science or technology has been made. However, it was noted in the Tribunal hearing that ‘we need to keep in mind what is often referred to as the shifting of the evidential burden’.
Paragraph 77 of the Tribunal hearing document stated that:
‘the relevance of the shifting of the evidential burden here is that there may come a point where GOL can say something along the lines of, “We have done enough to raise a case that our project comprised an overall advance in science and technology. What more can the Tribunal expect from us? The burden must now pass to the Revenue to produce some material to show that, despite what appears from everything we have produced, our project was a routine advance’
This is a potentially seismic ruling that completely undermines HMRC’s current tactic to disregard R&D projects as non-qualifying, without offering any sensible evidence as to why that position is being taken. This approach is the source of huge frustration to claimant companies – a ‘computer says no’ approach without any explanation. The GOL case suggests that HMRC should instead be able to put forward reasoned arguments why the statements made by the claimant company are not valid. Whilst the burden of proof remains with the claimant company, there appears to be an acknowledgment from the Tribunal that HMRC must be able to justify its position of refusal. This is a significant shift.
The Competent Professional
HMRC’s guidance on the notion of a competent professional states the following:
A competent professional is someone suitably qualified or experienced in the field. Usually this is someone directly involved in the project with professional expertise relevant to the advance being sought.
HMRC have reduced the value of some claims to zero when a competent professional has not identified that a company was seeking an advance in science or technology.
HMRC see a common error when identifying a competent professional. Having worked in a field or having an intelligent interest alone, do not make a person a competent professional. They must have enough knowledge and experience relevant to the qualifying project.
Whilst the above all seems reasonable, we have seen some staggering examples of HMRC denying claims on the basis that the people involved were not competent professionals. This is despite providing clear and convincing evidence to the contrary.
For software R&D claims (such as the GOL case), HMRC routinely argues that the competent professional must themselves be a software developer. This position is often taken further, and it is usual to see HMRC argue that the developer must be competent in the (often very narrow and specific) field of software that the claim relates to. Highly skilled and experienced developers are often regarded as not being competent by HMRC, for the simple reason of having spent a period of time working in an area of software which differs from the project which is the focus of the compliance check. In most examples we have seen, this is a baseless argument.
The GOL Tribunal hearing rejects the position currently being taken by HMRC. Edward Cahill, a former director of GOL, gave evidence on behalf of the company at the Tribunal hearing. Mr Cahill was also stated as a competent professional in the R&D report which was prepared by Myriad Associates. The Tribunal hearing document stated:
(Mr Cahill) accepted in cross-examination that he was not a software developer and that most people with his competences do not write code, but he said that he needs to be able to write code to be able to do his job.
Although Mr Cahill does not have any formal qualifications in this area (nor, we note in passing, does Sam Altman, who dropped out of his computer science course at Stanford), Mr Cahill was a very impressive witness, who spoke with complete fluency about the technical way in which GOL’s project worked and answered Mr Lewis’ questions with assurance…..we are completely satisfied that Mr Cahill has experience (including in coding) and up-to-date knowledge of software capabilities, albeit perhaps only in the area he works in, to be a “competent professional” for our purposes.
This is a notable departure from HMRC’s current position. The FTT accepted that Mr Cahill was a competent professional in the relevant field of software technology, despite not being a software developer himself. It is without question that over the past two years, HMRC will have rejected countless claims on the basis that the competent professional involved in the claim, was in fact, as per HMRC’s definition, not a competent professional.
HMRC Competence
Another key finding of the GOL case was the competency of the HMRC’s officers that dealt with the case. The Tribunal determined the following:
- The HMRC officer responsible for the case was a Mr Umar. The Tribunal hearing summary noted that ‘Mr Umar was in a difficult position, as he has no technology experience or expertise’.
- This was the first software claim Mr Umar had dealt with (!!)
- Mr Umar did not have any knowledge of the credentials of the in-house software development team at HMRC, from whom he sought advice when dealing with the case.
- The Tribunal noted ‘we found Mr Umar to be an honest, straightforward witness, who was clearly trying to help as best he could, but his lack of scientific knowledge or experience meant that his evidence was of no real help to us in deciding the issues before us’.
The findings of the Tribunal are astonishing. It has long been suspected that the officers rejecting R&D tax relief claims lack even the most basic knowledge about the technology under examination. The GOL case has proven this without any doubt.
The GOL case will likely serve as a warning to HMRC. If HMRC officers do not possess adequate competency in the relevant field of science or technology, the Tribunal will not place any value on the evidence put forward by HMRC.
Use of Existing Code
The Litigator acting for HMRC, Mr David Lewis, asked Mr Cahill during the proceedings if the software system being developed utilised existing code. Mr Cahill responded that ‘every piece of code is built on existing code; nobody writes code from scratch. Why would you when someone else has already done the work? GOL works by taking components and adding to them. It is rare for a software development to be completely novel’.
On this point, the Tribunal commented:
We also accept that using existing code (including from a code library) or other technologies already in existence (for example, using existing programming languages, frameworks and tools) is common in the software development world. We can see that for ourselves in the way the non-profit OpenAI organisation works, and we had evidence from Mr Cahill about one of the uses of GitHub. We do not consider that, of itself, the use of open source, or other existing, materials is an indication that a particular development is routine or readily discernible from publicly available materials.
Once again, the Tribunal’s view is very different from the position HMRC routinely adopts during compliance checks. We have encountered several examples of HMRC denying relief to software development companies which have utilised existing code taken from a code library. In some cases, the sole reason for denying relief was due to the code being already in existence.
The GOL case is without doubt a landmark judgement, not only for software development R&D claims, but for the wider R&D tax landscape. HMRC’s current position on several critical aspects of the relief have been rejected by The Tribunal. We will undoubtedly be reminded by HMRC that FTT judgements are not legally binding. That of course is true. However, there is little doubt that this was the decision many claimant companies and advisers have long been waiting for. We suspect there will be more to come.
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