The First Tier Tribunal (FTT) found that the company had failed to provide sufficient evidence that the costs claimed had actually been incurred

Emmanuel Quarm, director of Teksolutions-Inc Ltd, was appealing against a closure notice issued by HMRC.

This sought to reduce the company’s trading losses for the period ending 15 January 2015 from £174,025 to nil and for the period ending 20 October 2015 from £224,300 to nil. This also reduced the corporation tax payable for the two periods to nil.

Quarm argued that the losses should be allowed and would form the basis for an R&D credits claim by the company.  [Teksolutions-Inc Ltd and the Commissioners for Her Majesty’s Revenue and Customs, TC/2018/00696].

The tribunal heard there had been substantial correspondence between Quarm and HMRC about the information needed to process a claim for R&D tax credits under the corporation tax regime.

In November 2015, Teksolutions-Inc Ltd filed a tax return for the period 28 February to 21 October 2015, which recorded expenses of £246,500 and trading losses of £224,300.

The recorded expenses included £75,000 of salaries and wages; £62,000 of subcontractor payments; £30,000 of accountancy and audit fees; £24,000 of consultancy costs; £5,000 for entertaining and £12,000 of travel and subsistence, as well as smaller sums for advertising, light, heat and power, and bad debt.

A second tax return, for the period 28 February 2014 to 30 January 2015 contained similar figures, and gave recorded expenses of £182,825, with trading losses of £174,025.

HMRC subsequently wrote to Quarm asking for a detailed breakdown of the salaries, wages and subcontractor costs, and more detailed documentation to support the other expenditure said to have been incurred. In response, Quarm said that some suppliers had relocated or gone out of business, while the wages, subcontractor and accountancy fees had not yet been paid, but would be settled when funds were available.

He went on to state that he was in the process of ‘making a formal enquiry to eBay if there is the possibility of recovering my old invoices. A breach of security by an unknown user led to my entire account purchasing history being deleted.’

HMRC also requested a copy of the company’s cashbook, which Quarm said had been thrown away during a move, and he replied that this was difficult in the time available  as he was ‘at the moment incapable of performing any duties related to the business without any funds..’

By the end of December 2016, Quarm had supplied HMRC with limited documentation including amongst other items a mortgage statement for residential premises, details of debts and debt collection agencies, a Lloyds bank statement for 14 October 2016 to 24 November 2016, electricity bills for the residential property for the first nine months of 2015, and a lapsed insurance certificate for the residential property.

HMRC said the company had failed to supply the list of names and contact details of suppliers and a copy of the cashbook, as requested, so a £300 penalty was enforced.  The tax authority used its powers to request invoice details of the company’s spending directly from eBay.  When these were produced, these records showed purchases only of a personal nature including a child’s bike, a pair of trainers and a games console.

HMRC went on to give the company a penalty notice of £25,791, on the basis its behaviour in claiming on its tax returns expenses that were not properly claimable was deliberate and prompted. There was a 15% reduction for the quality of disclosure provided.

For his part, Quarm told the FTT that the company could not have carried out the research it had – which was evidenced by a slideshow presentation – if it had not incurred the expenditure it claimed. HMRC’s case was that the expenses claimed in the R&D analysis and the tax returns ‘did not correlate in any meaningful way’.

The FTT pointed out in its ruling that the bank statements provided for the company showed total incomings and outgoings which were substantially less than the expenses being claimed, suggesting the company did not have the requisite funds available to pay the costs it claimed to have incurred.

Some of the travel to Germany was for personal rather than business reasons, while one of the bad debts related to advice Quarm had given an acquaintance about improving a website for which no fee was agreed and no invoice was issued, but which he said would have provided £7,000 for the consultancy.

The tribunal described Quarm as a ‘deeply unsatisfactory witness’, who was willing to say whatever he thought would assist the company’s case, ‘regardless of whether it was true or not’.

The judges were especially critical of the ‘incredible account’ about why information on the eBay purchases was not available due to the actions of a saboteur, along with similar ‘cyber bullying’ claims that both the company’s PayPal and Companies House accounts had been hacked.

The judges concluded they were not willing to accept assertions the claimed expenses had been incurred wholly or exclusively for the purpose of the company’s trade. As there was no evidence of the claimed expenditure, then there could be no entitlement to an R&D tax credit, and the company’s appeal was dismissed.

Nigel Holmes, head of R&D technical operations at Catax, said: ‘This highlights how important it is that companies fully understand the R&D tax relief system. While separate R&D records are not required, companies must be able to justify all their R&D costs and have paid them before claiming.’

By Pat Sweet