Gravita’s team, led by Dion Laycock, Head of Tax Investigations, used their expertise in R&D tax to successfully defend a client in a recent HMRC investigation in an important victory for innovators.
R&D tax credit reliefs are a useful incentive for innovation in the UK. They let businesses reinvest tax savings into more innovation. However, obtaining tax credits for R&D projects is not always straightforward. They have come under increasing scrutiny from HMRC.
Our client works in the healthcare sector. They aim to improve outcomes for patients with obesity and type 2 diabetes. They use machine learning to achieve this goal. Their innovation connects patients with the most appropriate clinicians, specifically targeting individuals at risk of needing bariatric surgery.
Given the product’s novel architecture, the client filed a claim for R&D tax credits supported by a detailed report outlining the scientific and technological advancements achieved.
The R&D Tax Credit Claim
The client submitted the claim with its corporation tax return for the accounting period ending March 31, 2022. It included a detailed report on research activities and the innovative use of AI. However, HMRC quickly started an enquiry into the client’s claim.
The Dispute with HMRC
HMRC’s Initial Enquiry
HMRC’s response to the client’s R&D tax credit claim was almost immediate. Shortly after the submission, they issued a notice of enquiry, which signalled their intention to investigate. The speed with which HMRC’s response was issued suggests that the enquiry could have been automatically selected by algorithm rather than detailed review by an officer.
The quick response shows a larger trend in how HMRC handles R&D claims. They are becoming more sceptical of these claims. Such enquiries are often started without full understanding of the technical complexities involved in a case.
HMRC’s Standard Approach and Rejection
HMRC’s approach to R&D claims typically involves questioning the validity of a claim on two main criteria. Firstly, adherence to the generally accepted accounting principles (GAAP). Secondly, compliance with Department of Business, Energy and Industrial Strategy (BEIS) guidelines. In this case, HMRC asserted that our client did not meet these criteria, leading them to disallow the claim.
HMRC’s standard procedure in R&D enquiries is to issue a generic letter that asks the claimant to justify their eligibility. Our client submitted a detailed report.
However, HMRC decided that the project did not qualify for R&D tax relief. They stated that there was not enough convincing evidence to support the claim. This placed the burden of proof squarely on the client, which had to show that their project met the necessary criteria.
The Legal Process and Outcome
Preparing for the Tribunal
In defending our client, Gravita took decisive action. We requested an independent review of the case, hoping that a fresh perspective might lead to a different outcome. The review officer agreed with the original decision. They stated that the claim did not meet the technical requirements for R&D tax relief.
We then notified an appeal to the Tax Tribunal. This is not an uncommon scenario, as HMRC often rejects R&D claims, forcing companies into lengthy and costly litigation. Our strategy involved litigating directly at the Tax Tribunal and requesting a stay to enter Alternative Dispute Resolution.
HMRC’s Withdrawal
As the case progressed at the Tax Tribunal HMRC were required to submit their Statement of Case. Only at that point did HMRC’s litigator take the view that HMRC were unlikely to win at the Tax Tribunal. They directed the HMRC case owner to reverse the decision to disallow the relief. As a result, HMRC notified the Tribunal that they would not be defending the appeal and the client’s R&D claim was allowed, in full as originally claimed.
This case mirrored a similar case involving AI software company Get Onboard Limited where HMRC lost at the first-tier Tax Tribunal. The judge questioned their rigid approach, finding that HMRC needed to give better technical arguments. They must explain why the claim is not eligible for relief. Simply doubting the validity of claims is not enough. The parallels between the two cases likely influenced HMRC’s decision to withdraw.
Insights and Implications
Challenges in R&D Disputes
Our client’s case highlights the complexities involved in defending R&D tax credit claims, but it also shows that HMRC’s rigid stance can be successfully challenged. The client’s project was innovative – but HMRC’s initial rejection underscored the difficulties companies face in proving their eligibility for certain reliefs. Even when a competent professional validates a claim, HMRC might still reject it and force taxpayers into expensive legal battles.
The case also emphasises the importance of submitting a well-prepared technical report that explains clearly how a project meets R&D criteria. Although the client’s submission was initially met with scepticism by HMRC, it formed the basis of Gravita’s robust defence strategy to secure the claim.
Potential Impact on Future Disputes
The case was resolved in the client’s favour and might signal a shift in how HMRC manages future R&D disputes. It might become more selective about which cases to take to litigation, especially having recently lost similar disputes. Although not setting a binding precedent, where taxpayers win R&D cases at the first tier Tax Tribunal, those cases carry considerable weight and might influence how the first-tier Tax Tribunal decides similar disputes in the future.
The new Labour government has said that it will invest more resources into HMRC for investigations and enquiries. Much of the HMRC’s time will probably be directed to grey areas, where there is uncertainty and therefore a better chance of a result in their favour – such as R&D tax credit reliefs – so there they might take a tougher view in this type of investigation.
What next?
This case highlights the importance of using tax investigation specialists who can advise on how to hold HMRC to the legal framework and have detailed knowledge of mediation and litigation at the Tax Tribunal. Learn how we can help by contacting Dion Laycock, our Head of Tax Investigations.
