Introduction
In October last, a decision was published by the Tax Appeals Commission (“TAC”) that all companies claiming the R&D Tax Credit should be aware of. For the first time in the 20 year history of the tax credit, the Science Test had been the main focus of a case before the TAC.
The case related to the 2017 R&D Tax Credit claim made by a company operating in the animal breeding and husbandry sector. Three projects, accounting for €42,467 of tax credit, were refused by the Revenue Commissioners (“Revenue”). This was on the grounds that in Revenue’s view, they did not meet the required definition of R&D activities. Towards the end of 2020, the company lodged an appeal against Revenue’s decision.
The appeal hearing took place over three days in September 2023. During the hearing legal representatives and expert witnesses for both sides made their cases before the Appeal Commissioner, giving evidence and being cross-examined. In the end, the outcome was not good for the company, with the TAC finding in favour of Revenue on all counts.
We will now take a look at this important case. Our analysis takes place against the backdrop of claim environment in which there is widespread recognition of the need for improved clarity, consistency and certainty (“the Three C’s”) for all companies and in particular, for SMEs. As highlighted in the Report of the Commission on Taxation & Welfare in 2022, these companies need to be “encouraged to carry out R&D” by addressing their “difficulty and lack of certainty in ensuring they are compliant with the qualifying conditions or are keeping appropriate documentation”.
This is consistent with the Government’s own report, Impact 2030 Ireland’s Research and Innovation Strategy, which includes the following statement – “Over the coming years, it will be important to ensure that our R&I taxation offering continues to evolve, is targeted to stimulate additional SME activity and provides a strong incentive in light of the changing international tax landscape.”
Therefore in carrying out our analysis, we consider whether the case is likely to help or hinder the Three C’s of clarity, consistency and certainty.
Background
First, some background on the case involved. As all details that would enable the company to be identified are redacted in the TAC document, we do not know the name of the company or the livestock that was the focus of the projects. To assist with the flow of our analysis, we refer to the company as “BreedCo” and have randomly selected cattle as the livestock. However, as they say on TV, “Any resemblance is purely coincidental.”
A brief overview of the projects, as presented by BreedCo during the appeal hearing, is as follows:
Project A. Nutritional Trials
On Project A, BreedCo investigated the impact of several feed additives on the growth performance, health, vigour and condition of their animals.
Two trials conducted as part of the project focused on the diet of post-weaned calves. One explored the extent to which the calves’ feed intake could be increased by improving feed palatability using an additive and the benefits that might derive therefrom. Carried out over a 9 month period in 2017, results from the diet containing the feed additive were measured and recorded and compared with a control diet. Trial results showed improvements in mortality and growth performance. The second of these trials investigated the impact of including a medium-chain fatty acid in the diet with the view to improving diet efficiency. Intake of the acid and its impacts were measured and recorded.
The diet of lactating cows was the focus of another two trials carried out under the project. One trial explored the impact of adding an antioxidant with vitamin E to the diet while the other explored the health benefits that might derive from a different additive. In both cases, key performance metrics were taken and recorded to ascertain the impact of the diet.
Project B. Semen Extenders
On Project B, BreedCo investigated the impact of different semen extenders on the motility, morphology and longevity of their bull’s semen cells. Semen Extenders are solutions used in animal breeding to dilute and preserve the semen collected from males for artificial insemination purposes. According to BreedCo, their ultimate objective was to optimise performance of the semen cells, including fertility performance.
Project C. Genotype Development
BreedCo described how activities on Project C were carried out to ensure the genetic progress of their gene pool. Their research looked at inputs to Best Linear Unbiased Predictor (“BLUP”), by reference to feed intake. BLUP is a statistical method used in animal breeding to estimate breeding values for animals based on performance data and pedigree information. On the project, BreedCo used BLUP to investigate interactions between genotype and nutrition.
One of the expert witnesses appearing on behalf of BreedCo described how “innovative methods were used to measure the performance attributes leading to new knowledge with a view to specific commercial applications for the enhancement of genetic progress.”
The Decision
Following conclusion of the three day appeal hearing, the Appeal Commissioner issued his determination, finding in favour of Revenue on all counts i.e. that Projects A, B and C do not satisfy the definition of R&D activities for tax credit purposes. In his summary of the factors that contributed to his decision, the Appeal Commissioner stated that in his opinion:
- The projects did not seek to achieve scientific or technological advancement but instead advanced BreedCo’s own state of knowledge regarding its gene pool by means of routine activity.
- BreedCo was engaged in routine engineering rather than the resolution of scientific or technological uncertainty. The uncertainties that existed, such as they were, were capable of being resolved by competent professionals working in the field of breeding and husbandry.
- It was inherent in Projects A and B that the tests would prove or disprove the hypotheses being tested. There was no uncertainty involved in Project C at all.
- Projects A and B involved standard product assessment to ascertain commercial viability. Project C could be described as in the nature of a design objective.
- BreedCo did not know the composition of the active ingredients involved in some of the trials carried out under Project A.
- The research projects were carried out for BreedCo’s commercial benefit.
A more detailed explanation of each point was provided by the Appeal Commissioner in the “Analysis” section of his determination.
The Scimet view
When reading the case, an immediate response is to sympathise with the company involved, and not only because of the final outcome. The image we form of BreedCo is of a high-quality company, operating in a competitive and technically challenging sector.
In addition to their R&D coordinator, two highly qualified expert witnesses attended the hearing to attest to the merits of BreedCo’s claim, one referencing the company’s “good facilities” in his evidence. The Appeal Commissioner himself stated that he “does not doubt that the Appellant approached the matter in good faith, and carried out a large amount of preparatory work in advance of the appeal…..”.
Contrary to counsel for Revenue’s suggestion that “there had been a lack of engagement with the requirements of the statute” by BreedCo, it appears to us that the company took its responsibilities under the R&D Tax Credit scheme seriously.
And yet, their audit experience seems to have been more stressful than it needed to be. For example, during the appeal hearing it emerged that no request was made to BreedCo, either during or after the audit, for details pertaining to the composition of ingredients in products used in the Project A trials. This is surprising given it was the absence of these details that was found to be so egregious to the project’s eligibility.
We also learn that following receipt of the draft report from Revenue’s appointed expert after the audit visit, BreedCo made a further submission, presumably to address points raised in the draft report. However, it was confirmed during the hearing there was no engagement with BreedCo regarding this submission and no update was made to the draft report to reflect its contents.
We also hear that BreedCo had a number of other projects in its 2017 R&D Tax Credit claim that were accepted as eligible despite the fact that they also concerned the company’s gene pool. This inconsistency was acknowledged by Revenue’s appointed expert. A statement from him that if he was to write his report again he “would not allow these experiments” appears to have been accepted as bringing closure to the matter.
So from a purely procedural point of view, we would suggest that there are some lessons to be learned to improve the audit experience for companies.
Tax Technical/Legal Arguments and Interpretations
BreedCo had 42 days to appeal the TAC decision to the courts. Given the company’s experience to date and the substantial time and resources that must already have been invested in preparing/supporting the claim, it would be understandable if they decided not to pursue this option. From our perspective as R&D Tax Credit specialists, we believe it would be interesting and useful to have some of the arguments, interpretations and statements from the case further elucidated in the courts. A detailed examination of each of these points is beyond the scope of this article. Instead, we highlight a number of observations that we feel are relevant to the examination of the Science Test.
1. Frascati (Front And) Centre
When reading the TAC’s decision, a number of words jump out due to their repeated use e.g. “transferability“, “reproducibility” and “dissemination“. The perceived absence of these in BreedCo’s projects was viewed as damaging to their case. Given their prominence in the decision, one might expect to find numerous references to them in the relevant tax legislation or at least, in Tax and Duty Manual Part 29-02-03 (also known as the R&D Tax Credit Guidelines). However, this is not the case. Instead it is the 2015 version of the OECD’s Frascati Manual where they are first afforded such distinction.
For the non-R&D Tax Credit nerds among us, the OECD’s Frascati Manual is a widely recognized international standard for measuring R&D activities. First introduced in 1963, it provides guidelines for the collection and interpretation of R&D statistics, aiming to ensure consistency and comparability across countries. Like many jurisdictions around the world, when the R&D Tax Credit was being introduced in Ireland, some definitions included in the legislation were based on definitions found in the manual.
Still, it was somewhat surprising to see the Frascati Manual play such a prominent role in this case. Just to be clear, this is in no way to disparage what is a very informative and useful publication. At SciMet R&D, our tax credit specialists always have a copy of the manual close to hand when delivering our market leading R&D Tax Credit services. However, this is always done with the clear understanding that it is not Irish tax legislation, and the relevant sections of the Taxes Acts always take precedence.
In the same way, we would like to see the Irish tax legislation and accompanying guidelines that have been in place for 20 years, given clear priority in the examination of the Science Test. Where all attempts to apply these have been exhausted, reference to external sources such as the Frascati Manual is an option. However, in our view, in the interest of the Three C’s, this needs to be done in a carefully controlled manner and should be accompanied with a clear explanation as to why the Irish tax legislation and accompanying guidelines are considered deficient in dealing with the question in hand.
To further explore these points, we use an analogy – Mel Gibson’s epic historical drama, Braveheart.
Braveheart is based on the life of William Wallace, a Scottish warrior who led the Scots in the First War of Scottish Independence against King Edward I of England in the late 13th century.
In the movie, a romantic relationship is portrayed between Wallace and Princess Isabella of France, the wife of Prince Edward II. However, this relationship never happened. Isabella was in fact born in 1295, just 10 years before Wallace’s death in 1305.
Like many movies “based on” real persons or events, Gibson selected certain historical facts that he wished to convey and combined these with other elements to deliver on his overall vision. Therefore, “based on” is not a carbon copy of the underlying source.
Furthermore, to remove the relationship from the movie now, is not as simple as making a few editorial cuts. It would necessitate significant revisions to the script, potentially impacting various elements of the story, including character motivations, plot dynamics, and emotional resonance.
When first introducing the R&D Tax Credit legislation and accompanying guidelines in 2004, decisions were made at that time as to sources that definitions/guidance might be based upon, what should be included and what should be left out. Once these decisions were made, they became interwoven in the larger legislative fabric. Just like in the movies, “based on” is not exact replication of the original. Also, any subsequent changes in these secondary sources and/or in how they might be applied (e.g. a broadening/narrowing/refocusing of application) requires careful consideration to ensure consistency with other legislation, guidance and policy objectives. Not doing so, can have unintended and/or adverse impacts, an example of which we discuss next.
2. It's not Academic
In the earlier days of the R&D Tax Credit in Ireland, a common complaint encountered was that measures and expectations more relevant to academic research were being applied to evaluate business R&D projects. Thankfully, with good, positive engagement between the various stakeholders (e.g. Revenue Commissioners, R&D companies, Representative Bodies, R&D Tax Credit Advisors) on the distinctions between Academic Research and Business R&D, real progress was made on the issue and as a result, the complaint has been heard less frequently in recent years.
With “dissemination of results“, or the perceived lack thereof, afforded such importance in BreedCo’s case, the question needs to be asked – Does this mark a return of the Academic Research v Business R&D debate? For example, during cross examination of one of BreedCo’s expert witnesses, the question was put to him as to whether the research had been disseminated to other breeders. Presumably, the implication being that not having done so was somehow damaging to the company’s case. The Appeal Commissioner noted during delivery of his findings of material fact that “results were shared within the Appellant and with its customers, but not disseminated more widely“.
It is well known that unlike in academia where publication is often the primary objective, businesses can pursue different strategies to exploit the new knowledge derived through R&D. For example, some companies may seek patents while others might decide to protect their IP as trade secrets that can then be applied in the business to gain a competitive advantage. Therefore, dissemination of results, in an academic research sense, should not be a requirement or an expectation of a business R&D project.
Another observation is that at times, interactions between the expert witnesses on both sides during the appeal hearing came across a little like this:
However, rather that busting out windmills and airflares, academic papers were the weapon of choice. At times it was akin to a game of Lit Review Hold ‘em – I will see your Greek paper that “if it was a very good paper it would not have been published in a Greek journal” and raise you a US research study that may or may not be relevant to the claimant’s projects. The Appeal Commissioner noted the “lack of proper engagement by the expert witnesses retained by both sides with the arguments of the other…“. Perhaps better engagement would have allowed for a more thorough examination of the extent to which the academic papers could have been relied upon by BreedCo without conducting further R&D. The requirements and risks faced by a business are different to academia and therefore, direct application of academic papers in a business context should not be assumed.
As it was, the literature review appears to have been relied upon almost exclusively for establishing what was considered as known and available to a competent professional in the field. There was little mention of other approaches often encountered in business R&D projects such as internet searches and competitor analysis.
3. The pursuit of new knowledge for commercial gain
At various stages during the appeal hearing, reference was made to BreedCo’s commercial motivations in carrying out the projects under review. For example, counsel for Revenue stated that Breedco “had tested products to ascertain whether they were commercially viable for it, which was not sufficient basis for saying that an R&D credit should apply. The pursuit of commercial profit or the undertaking of commercial endeavour did not equate, of itself, to meeting the requirements for R&D credit relief”.
Having re-read the determination numerous times, it is not clear to us where BreedCo equates the pursuit of commercial profit or the undertaking of commercial endeavour to meeting the requirements for an R&D Tax Credit claim. Likewise, from the available information, we do see uncertainty as to the commercial viability of new products presented as technological uncertainty.
Furthermore, just as the pursuit of commercial profit does not equate to eligibility for R&D Tax Credits, the fact that a company considers future commercial gain that may derive from the new knowledge should not be viewed as fatal to a claim. In fact, when one considers the definition of experimental development used for R&D Tax Credit purposes (see below), the subsequent commercial application of knowledge appears to not only be accepted, but expected:
“ work undertaken which draws on scientific or technical knowledge or practical experience for the purpose of achieving technological advancement and which is directed at producing new, or improving existing, materials, products, devices, processes, systems or services including incremental improvements thereto”
As can be seen, the legislation refers explicitly to work undertaken to acquire new knowledge (i.e. technological advancement) and which is directed at producing new or improved materials, products, devices etc. These new or improved materials, products, devices etc. are presumably being produced to generate a commercial gain.
Conclusion
If it was hoped that the first case in Ireland to focus on the Science Test would bring clarity to some of the more challenging and subjective aspects of the R&D Tax Credit, we are not sure if that has been achieved. As highlighted above, there are a number of points that we believe now require careful analysis and consideration to ensure any application beyond this case has the intended impact. On the 20th anniversary of the introduction of the R&D Tax Credit in Ireland, now seems an opportune time to address these important questions and to provide R&D companies in Ireland with the clarity, certainty and consistency that they are long overdue.