In Monitor Audio Ltd v HMRC, the First-tier Tribunal (FTT) has allowed the taxpayer's appeal, concluding that research and development (R&D) tax deductions were available to it under section 1044, Corporation Tax Act 2009 (CTA 2009).
Monitor Audio Limited (Monitor) is a designer and distributer of loudspeakers. It claimed R&D deductions, at the rate of 75% available to small and medium-sized enterprises, for the accounting periods ending 30 September 2010 and 30 September 2011, amounting respectively to £430,097 and £755,284.
As a result of a management buy-out in 2007, West Register (Investments) Limited (West Register), which was a 100% subsidiary of Royal Bank of Scotland (RBS), held 43.75% of the ordinary shares and 26.22% of the voting rights in Monitor. The buy-out was funded by £8.7 million in secured credit facilities from RBS, and £2.6million in equity from Total Capital Finance Limited (Total Capital), a company within the RBS group. When Monitor ran into financial difficulties in 2008 and was unable to finance its debts, a debt for equity swap was agreed between Monitor and RBS. The shares that RBS and Total Capital obtained as a consequence of this agreement were subsequently transferred to West Register.
Monitor's corporation tax computations for the relevant periods included a 75% deduction for R&D expenditure available to small and medium-sized enterprises, under section 1044, CTA 2009. It noted RBS's shareholding in it, but suggested that it was an 'institutional investor' under EU Recommendation 2003/361.
HMRC opened enquiries and subsequently issued closure notices refusing the claim on the basis that Monitor was not entitled to the R&D deductions claimed as it was not a small or medium-sized enterprise. An internal review upheld HMRC's decision to deny relief and Monitor appealed to the FTT.
The FTT's decision
The question for the FTT to consider was whether, with the considerable shareholding of RBS, Monitor was a small and medium-sized enterprise.
Section 1119(1), CTA 2009, defines a small or medium-sized company as a "micro, small or medium-sized enterprise as defined in Commission Recommendation (EC) No 2003/361…".Most pertinent is Article 3 of the Recommendation, which provides a definition of a 'partner enterprise' to include an upstream enterprise which holds more than 25% of the capital or voting rights of another enterprise. However, an entity will not be treated as a partner enterprise if the upstream enterprise is a 'venture capital company' or an 'institutional investor'. Due to limited evidence provided about the activities, strategies and risk appetite for the relevant periods, the FTT agreed with HMRC and concluded that West Register was not to be treated as a venture capital company.
The FTT then considered whether West Register was an institutional investor, for the purposes of Article 3. It considered the definition of an institutional investor provided in Article 3 of the Commission Recommendation (EC) No2003/361 "an investment organisation which aggregates investments from a number of, or on behalf of, small investors. The essential test is whether the investor, through its involvement in the company, was putting the business in a stronger market position. In the present case, the evidence demonstrated that West Register and RBS had little involvement in the management of Monitor. The FTT therefore concluded that both West Register and RBS satisfied the definition of an institutional investor for the purposes of Article 3. As West Register and RBS satisfied the definition of institutional investor, Monitor was to be treated as a small and medium-sized enterprise and was entitled to claim R&D relief. The appeal was therefore allowed.
The FTT has provided some helpful guidance on the meaning of institutional investor in this context. In the view of the FTT, the essential test is whether the investor, through its involvement in the company, is putting the business in a stronger market position. In the present case, the evidence established that West Register and RBS had very little involvement in the management of Monitor.