Judgment summary
Environmental Services Limited (ESL) appealed against closure notices issued by HMRC under schedule 18 to the Finance Act 1998 for accounting periods ended 31 July 2020 and 31 July 2021, which disallowed ESL's claims for research and development enhanced expenditure and consequential R&D tax credits (1, 2).
The Tribunal considered two issues: whether ESL's activities qualified as research and development for tax purposes, and if so, the extent to which its expenditure qualified for relief (4). ESL bore the burden of proof on the balance of probabilities (5).
The Tribunal heard evidence from Miss Kellee Boller, a director of ESL, and Mr Aiden Race, an additional yard foreman, both of whom were found to be truthful and their evidence unchallenged (6). The two projects concerned methods of loading, agitating and separating waste, and adapting a vehicle known as "the Hulk" to improve waste collection efficiency, driven primarily by the need to service a contract to dispose of waste from the M1 motorway upgrade (15, 16, 25, 26, 91).
The Tribunal found that Mr Race qualified as a competent professional under the BEIS Guidelines but that Miss Boller did not (80, 81). The Tribunal accepted that ESL had an unwritten method or plan (86), but concluded that ESL failed to establish that it was seeking an advance in overall knowledge or capability in a field of science or technology, or that it faced genuine scientific or technological uncertainty as defined by the Guidelines (90, 93, 94).
The Tribunal also found that, even if qualifying R&D activities had been established, ESL had not proven the amount of qualifying expenditure, given unclear methodology for staff time allocations and invoices that appeared to relate to routine operational costs (102-107). The appeal was dismissed (111).
Background
ESL, incorporated on 3 September 2002, collects and transports waste to disposal sites but does not process waste itself (8). It is jointly owned by Miss Boller and Mr Robert Moore (9). Previously a skip business, ESL began transporting waste using tankers during Miss Boller's time in charge (10). ESL is a small company with 10 staff and two directors for the year ending 2020 (13).
A regulation change around 2016/2017 restricted the waste disposal sites ESL could use depending on waste type (14). In July 2019, ESL won a contract to dispose of waste from the M1 motorway smart motorway upgrade, generating significant time pressure due to overnight motorway closures and the closure of waste disposal sites at night (15).
Miss Boller stated the combination of regulatory change and time pressure from the M1 contract drove ESL to seek innovations (16). ESL claimed R&D relief for two interlinked projects: 'Loading, Agitation and Separation Methods of Effluent, Toxic and Recyclable Materials' and 'Agitation Methods of Tankers', involving storage tanks, agitation technology, and modifications to a vehicle called 'the Hulk' (25, 26).
ESL claimed relief for percentages of Mr Race's and the directors' salary costs, along with various invoices for maintenance, materials and equipment hire, for both accounting periods (30-35).
Core dispute
The dispute centred on whether ESL's two projects constituted research and development for tax purposes under Chapter 2, Part 13 CTA 2009 and the BEIS Guidelines on the Meaning of Research and Development for Tax Purposes, and if so, the extent of qualifying expenditure (4, 36).
ESL submitted that both projects involved genuine technological uncertainty not resolvable through routine industry knowledge, that the work was systematic and experimental rather than routine, that Mr Race and Miss Boller were competent professionals, and that limited contemporaneous evidence should not be fatal to the appeal (37).
HMRC submitted that ESL had failed to show the projects were started with the intention to achieve an advance, that they were conducted according to a set plan addressing scientific or technological uncertainties, what those uncertainties were, or what the baseline level of knowledge in the relevant field was. HMRC also submitted that ESL failed to demonstrate that the expenditure claimed was allowable and related to the two projects (38, 39).
Court findings
The Tribunal found that Mr Race was a competent professional given his approximately 40 years of practical experience, involvement in identifying problems and designing solutions, and his role in designing the Hulk vehicle, but found that Miss Boller was not a competent professional (80, 81).
The Tribunal accepted that ESL had an unwritten method or plan, with Mr Race making suggestions to resolve practical problems identified by Miss Boller (86). However, the Tribunal found that ESL failed to establish that it was seeking an advance in overall knowledge or capability in a field of science or technology, finding instead that the projects were directed at improving ESL's own operational capability to service the M1 contract (90, 91, 98).
The Tribunal accepted that the work involved experimentation and trial and error but held that experimentation alone does not constitute R&D, and that this did not demonstrate technological uncertainty within the meaning of the Guidelines (92). The Tribunal was not satisfied that ESL established the existence of technological uncertainties, nor was it provided with a clearly articulated technological baseline from which any advance could be measured (94, 95).
The evidential position for the accounting period ended 31 July 2021 was found to be particularly limited (96, 100). The Tribunal rejected HMRC's characterisation of the activities as merely routine day-to-day operations, but nonetheless found the activities did not meet the Guidelines' requirements for R&D (99).
On expenditure, the Tribunal found that even had qualifying R&D activities been established, ESL had not proven the amount of qualifying expenditure, citing unclear methodology for staff time percentages and invoices that appeared to relate to routine maintenance, transport management, equipment hire, labour, inspections and PPE (102-104). The Tribunal agreed with HMRC that leased equipment, even if used in R&D activities, was not consumed as part of the process and so could not qualify as a consumable (105). The Tribunal declined to apportion expenditure on a just and reasonable basis absent an evidential foundation (106).
Outcome
The appeal was dismissed. The Tribunal held that ESL had not established on the balance of probabilities that the activities relied upon constituted research and development within the meaning of the BEIS Guidelines, and had not established the amount of qualifying expenditure attributable to those activities (109, 111).
Major issues / areas of contention
- Whether ESL's activities relating to waste loading, agitation and separation methods, and vehicle modifications, qualified as research and development for tax purposes under the BEIS Guidelines.
- Whether the projects sought to achieve an advance in overall knowledge or capability in a field of science or technology, as opposed to merely improving ESL's own operational capability.
- Whether ESL demonstrated genuine scientific or technological uncertainty, as opposed to practical or commercial challenges.
- Whether Mr Race and Miss Boller qualified as competent professionals for the purposes of the Guidelines.
- Whether ESL had a method or plan for the alleged R&D activities.
- Whether ESL established the amount of qualifying expenditure, including staff time percentages and various invoices, attributable to the alleged R&D activities.
- Whether leased or hired equipment could qualify as a consumable item for R&D relief purposes.