BE Studios Ltd. v Smith & Williamson Ltd

The Claimant, B.E. Studios Ltd (“BES”) is a company incorporated on 30^th June 1999 specialising in the design, production and sale of computer software for computer games and other commercial uses. The company appears to have been the brainchild of three individuals, Mr Ted Evans (“Mr Evans”), Joanna Berry (“Miss Berry”) and Christopher Dickens (“Mr Dickens”). Mr Evans’ background was as an artist and designer. From 1994 to 1999 he was a director and shareholder of a Seattle based company called EPG Studios Inc (“EPG”). During this period he contributed to the design and production of two computer games using the Internet. By the time of the incorporation of BES he had acquired a considerable reputation as a designer of computer games and other computer products. It is accepted that by the beginning of the period with which this case is concerned Mr Evans, although not having had any formal technical training, was able to combine his skill as a draughtsman and designer with a considerable knowledge of computer technology. It is not known why Mr Evans ceased working for EPG and came to work for BES of which he became a director holding 35 of its 85 issued shares. At the time of doing so Mr Evans, although married and with a family, had formed a personal relationship with Miss Berry and BES was acting as a distributor in the United Kingdom for computer games designed and produced by EPG.

Miss Berry, although legally qualified, had a background of working in the media. She held 25 of the issued shares of BES. At all material times Miss Berry was the managing director of BES and Mr Evans was its creative director.

Mr Dickens holds the remaining 25 issued shares of BES and is a director. He has had a long career in media and marketing related business with substantial interests in that business. It was not intended that he should have any part in the day-to-day management of BES but would provide strategic overview and useful contacts. He played an important part in raising capital for the launch of BES and appears, himself, to have advanced money for that purpose.

The Defendant, Smith & Williamson Ltd (“S&W”) is a company incorporating the accountancy business of a well-known firm of chartered accountants. By a retainer letter dated the 20^th October 2000 S&W were retained to provide taxation and financial planning advice and accounting services to BES.

In the meantime on the 28^th July 2000 sections 68 and 69 of the Finance Act 2000 (“the 2000 Act”) came into force. Section 68 of and schedule 19 to that Act gave effect to a new definition of “research and development” inserting a new section 837A into Part XIX of the Income and Corporation Taxes Act 1988 (“the 1988 Act”). The effect of that section and of regulations made under it was to clarify the extent and meaning of “research and development” (“R&D”) for the purposes of the 1988 Act. By section 69 and schedule 20 of the 2000 Act there were set out the requirements to be satisfied for tax relief to be available in respect of expenditure on R&D, in particular, expenditure qualifying for relief was defined.

It is accepted that S&W, although they considered the possible application of these new provisions to BES, did not inform BES of them. In consequence BES did not become aware of these provisions until 2002 when application was made for the consequent payment by the Revenue and such payment was received. S&W accept that the failure to notify BES of the possible availability of R&D relief constituted a breach of their retainer and negligence. The issue in the case is whether such admitted breach has in fact caused recoverable damage to BES. It is S&W’s case that the Inland Revenue has made payment on BES’ claims for R&D relief in error because BES never qualified for R&D tax relief or, if it did, only in respect of sums much smaller than actually received. In consequence it is S&W’s case that BES having received payment of their claim for R&D relief, albeit late, have suffered no loss resulting from their admitted breach.

I have already described the incorporation of BES and the backgrounds and roles of its directors and shareholders. Following its incorporation BES commenced business on a relatively small scale. It began recruiting employees in April 2000 and by June 2000 the recruitment of its key workforce was complete. Ultimately BES had a permanent staff of twelve, Mr Evans as creative director and Miss Berry as managing director, an office manager, two project managers, two programmers, an artistic director and five designers. There was a certain amount of staff turnover during the period in question.

Initially BES, in addition to selling licences for games produced by EPG, carried out web site design on behalf of clients and developed ideas for new games and other commercial computer products to offer to clients. BES’ accounts for its first period of trading to 30^th June 2000 showed a modest loss of £25,637 on a turnover of £217,058. The loss was subsequently reduced by the incorporation into the accounts of £11,200.32 for R&D relief. Its balance sheet showed, as current assets, debtors of £89,348 and cash at bank of £170,131. May 2000 marked the peak of the Financial Times index for Information Technology stocks which fell steeply until June 2000. There was then a partial recovery to a new peak in September 2000 and thereafter a steady fall bottoming in September 2002 after which the index has hardly recovered at all.

BES’ accounts for the year to 30^th June 2001 show turnover reducing to £155,611 with administrative expenses increasing from £230,00 to £572,772 resulting in a loss before taxation of £459,035. That loss was subsequently reduced to £356,740 by the incorporation into the accounts of £102,295 of R&D relief. The balance sheet shows no trade debtors, cash at bank of £7,765 and current creditors of £52,559. It also shows long-term loan creditors of £189,673. It is accepted that the long-term loans were from the directors and person connected with the company. During that year £255,526 of loan creditors shown in the June 2000 accounts were capitalised into shares. It is accepted that by this stage BES was paying £33,000 a month in expenses in relation to the employment of its directors and staff.

It seems that from early 2001 it was realised that in order to survive, BES required an injection of capital. Accordingly steps were taken to prepare a prospectus. On the 25^th April 2001 LF Consulting Group Ltd were instructed to assist BES in the preparation of a business plan for that purpose. In June an 80 page document called an “Information Memorandum” was produced with the assistance of Mr Price of LF Consulting. The following passages from this document illustrate how BES saw itself.

“1.1

The Vision

BE Studios’… goal is to become the world’s premier creator and producer of interactiveentertainment.

Just as film, radio and television revolutionised the way people are entertained, management believe that the evolution in the technologies of interactive platforms heralds the beginning of another, even more dramatic revolution. Interaction with, and response to, entertainment will never be the same again.

BE is poised to seize the opportunities presented by these technologies. Its approach is unique: creating interactive experiences, with no limits imposed upon the viewer’s imagination…

Management believe that BE benefits from the following areas where it holds competitive advantage:

BE’s key management and staff have knowledge of traditional media, marketing and advertising that is critical to the success of BE’s interactive entertainment products (IEP) in the market.

BE understands the technology intimately and has the experience to implement new technologies as they emerge.

BE’s business is focussed solely on the creation of interactive entertainment.

BE has the experience creativity market know-how and track record to succeed in this difficult market.

1.2

History and Background

BE creates a range of original and commissioned IEP, which are distributed to consumers via digital interactive TV, PC or Mobile Internet (using Broadband or Narrowband technology as appropriate).

Since its foundation, BE has focussed on commissioned IEP business…

During the last 8 months (since the dramatic decline of Internet related businesses) the Company has built up a library of original interactive products…

Development of IEP concepts

The Company develops creative concepts from its own “creative incubator” and from ideas presented to it, either by third party creators or from already established concepts seeking a different platform from their original production (e.g. the interactive versions of traditional television programs). …

Whilst the IEP developed by BE are platform independent, the source of the creative concept varies greatly, which provides for different levels of IPR remaining attributable to the Company.”

Paragraph 1.6.1 the Information Memorandum, after recording the trading losses shown in its accounts to 2000 and 2001 projected a continuing loss in the accounts to June 2002 of more than £2M but a profit in the year to June 2003 of just more than £1M rising to £4.8M in the year to 2004.

The Information Memorandum was published but failed to produce any investors. In the second six months of 2001 BES’ position further deteriorated. The business of a major potential customer, Gameplay.com Plc, collapsed. An anticipated contract from BES’ major customer, Flextech Television Ltd did not materialise. The bank overdraft, guaranteed by Mr Dickens up to £35,000 was extended. By October the relationship between Mr Evans and Miss Berry had ended.

In early December 2001 the whole of the BES’ staff were made redundant, its office equipment, including its computers, was sold and its premises vacated. The decision to effect this has been referred to throughout the proceedings as the “mothballing” of BES. In addition to the staff both Mr Evans and Miss Berry left the company to seek employment elsewhere,Mr Evans to Flextech, initially on secondment for a brief period but then to permanent employment.

These events were illustrative of what was going on throughout the information technology business. There was no recovery throughout 2002. During that year Flextech and its parent Telewest Communications Plc, whose accounts for the year 2001 and 2002 were in evidence, were subject to substantial financial difficulties. Market sentiment had been badly affected by the events of September 11^th 2001. On the 27^th March 2002 ITV Digital was placed in administration. If the index for information technology stocks is a reliable guide the profitability of companies has remained depressed at least till the end of 2004.

The existence of R&D tax relief first came to BES’ attention as a result, it seems, of the intervention of Mr Price in April or May 2002 but it was not until the 17^th June 2002 that Mr Hyde, the financial controller of BES, telephoned Miss Warner of S&W to ask her to look into it. In the result an application was made to the Revenue for relief in respect of the tax year to 30^th June 2000 by letter dated the 26^th June 2002 claiming payment of the sum of £11,200.32. The text of this letter was prepared by Mr Price. The Revenue made payment of the full amount claimed in August 2002. Thereafter an application was made for R&D relief relating to the tax year to the 30^th June 2001 on the 28^th August 2002 in the sum of £102,294.79 which the Revenue again paid in full in January 2003. Finally an application for the year to 30^th June 2002 was made on the 4^th February 2003 in the sum of £38,367, which was paid in full by the Revenue in March 2003.

Under the heading “meaning of “research and development” section 68 of the 2000 Act provides:-

“68(1) Schedule 19 to this Act (meaning of “research and development”) has effect.

In that Schedule-

Part I contains a new definition of "research and development” for the purposes of the Tax Acts…”

Schedule 19 to the 2000 Act has the effect of inserting into Part XIX of the1988 Act a new section 837A which provides:-

“837A.— Meaning of “research and development”.

(1)

The following provisions have effect for the purposes of, and subject to, the provisions of the Tax Acts which apply this section.

(2)

“Research and development” means activities that fall to be treated as research and development in accordance with normal accounting practice.

This is subject to regulations under subsection (3) below.

(3)

The Treasury may by regulations provide—

(a)

that such activities as may be prescribed are not “research and development” for the purposes of this section, and

(b)

that such other activities as may be prescribed are “research and development” for those purposes.

(4)

Regulations under subsection (3) above may—

(a)

make provision by reference to guidelines issued (whether before or after the coming into force of this section) by the Secretary of State, and

(b)

make such supplementary, incidental, consequential or transitional provision as appears to the Treasury to be necessary or expedient.

(5)

In subsection (2) above “normal accounting practice” means normal accounting practice in relation to the accounts of companies incorporated in a part of the United Kingdom.”

The words “normal accounting practice” in sub-section (2) of section 837A refer to the provisions of SSAP 13. That document defines R&D at paragraphs 5,6 ,7 and 21 as follows:-

“5

Research and development activity is distinguished from non-research based activity by the presence or absence of an appreciable element of innovation. If the activity departs from routine and breaks new ground it should normally be included; if it follows an established pattern it should normally be excluded.

6

Examples of activities that would normally be included in research and development are:

(a)

experimental, theoretical or other work aimed at the discovery of new knowledge, or the advancement of existing knowledge;

(b)

searching for applications of that knowledge;

(c)

formulation and design of possible applications for such work;

(d)

testing in search for, or evaluation of, product, services or process alternatives;

(e)

design construction and testing of pre-production prototypes and models and development batches;

(f)

design of products, services, process or systems involving new technology or substantially improving those already produced or installed;

(g)

construction and operation of pilot plants.

7.

Examples of activities that would normally be excluded from research and development include:

(a)

testing and analysis either of equipment or product for purposes of quality or quantity control;

(b)

periodic alterations to existing products, services or processes even though these may represent some improvement;

(c)

operational research not tied to a specific research and development activity;

(d)

cost of corrective action in connection with break-downs during commercial production;

(e)

legal and administrative work in connection with patent applications, records and litigation and the sale or licensing of patents;

(f)

activity, including design and construction engineering, relating to the construction, relocation, rearrangement or start-up of facilities or equipment other than facilities or equipment whose sole use is for a particular research and development project;

(g)

market research.

21

Research and development expenditure means expenditure falling into one or more of the following broad categories (except to the extent that it relates to locating or exploiting oil, gas or mineral deposits or is reimbursable by third parties either directly or under the terms of a firm contract to develop and manufacture at an agreed price calculated to reimburse both elements of expenditure):

(a)

pure (or basic) research: experimental or theoretical work undertaken primarily to acquire new scientific or technical knowledge for its own sake rather than directed towards any specific aim or application;

(b)

applied research: original or critical investigation undertaken in order to gain specific or technical knowledge and directed towards a specific aim or objective;

(c)

development: use of specific or technical knowledge in order to produce new or substantially improved materials, devices, products or services. To install new processes or systems prior to the commencement of commercial production or commercial applications, or to improving substantially those already produced or installed.”

The provisions of sub-paragraphs 6(d) (e) (f) and sub-paragraph 21(c) would seem to be those which apply to the operations of BES as described in the Information Memorandum.

Because the provisions of SSAP 13 are, by sub-section (2) of section 837A made subject to regulations made under sub-section (3) of that section, the provisions of SSAP 13 act as a “gateway” through which all claims for R&D relief must pass to be allowable but all applications must then be examined in the light of the regulations made by the Treasury under sub-section (3). By sub-section (4) of section 837A the Treasury Regulations made under sub-section (3) “may make provision by reference to guidelines issued …by The Secretary of State…” This is a reference to the Secretary of State for Trade and Industry.

On the 21^st August 2000 there came into force the Research and Development (Prescribed Activities) Regulations 2000 made by the Treasury, (“the Revenue Regulations”). Paragraph 3 of the Revenue Regulations provides as follows:-

“Prescribed activities

3.

- (1) The activities prescribed by paragraph (2) of this regulation are not “research and development” for the purposes of section 837A and the activities prescribed by paragraph (3) of this regulation are “research and development” for those purposes.

(2)

The activities prescribed by this paragraph are activities that fall to be treated as not being research and development in accordance with the Guidelines.

(3)

The activities prescribed by this paragraph are activities that fall to be treated as research and development in accordance with the Guidelines.”

In paragraph 3 the reference to guidelines refers to the “guidelines on the meaning of research and development (R&D) for tax purposes” (“the DTI Guidelines”) which were issued for the purposes of section 837A on the 28^th July 2000. It follows that the final tests which all applications for R&D relief have to meet are those contained in the DTI Guidelines. Under the heading “definition of R&D” those Guidelines provide:-

“Definition of R&D

The overarching definition of R&D for tax purposes follows that used for the purposes of normal accountancy practice for UK companies in Accounting Standard SSAP13. The definition in SSAP13 is itself based on the definition developed by the OECD for the purposes of statistical surveys of R&D (commonly referred to as “Frascati”). Frascati defines R&D as comprising “creative work undertaken on a systematic basis in order to increase the stock of knowledge … and the use of this stock of knowledge to devise new applications”. But the humanities are excluded because they do not fall within the fields of science or technology.”

Having summarised the provisions of SSAP 13 which I have set out above, the DTI Guidelines continue as follows:-

“The Boundary of R&D and Other Related Activities

9.

Identifying the boundary between R&D and non-R&D activities can sometimes pose practical difficulties. But an activity will be R&D if carried on in the field of science or technology and undertaken with a view to the extension of knowledge.

10.

R&D is thus characterised by work which breaks new ground and the novelty of what is being created in an atmosphere of scientific or technological uncertainty, and if successful will result in the extension of scientific or technical knowledge (although it is recognised that R&D will not always be successful). R&D should be founded on the investigation and exploitation of a scientific principle. This may be in pursuit of the creation or development of, for example, new liquids, substances, materials, software, designs, products, processes, technology or knowledge. R&D may result in intangible as well as tangible outputs.

11.

Within this context, activities will be R&D if they consist of:

the application of new scientific or technological principles in an existing area of investigation; or

the application of existing scientific or technological principles in a new area of investigation.

12.

Care must be taken to distinguish R&D from other activities that may be part of the wider innovation process. R&D will not include activities based upon the use of well-established products or processes, which may be new to the user but do not represent any departure from common knowledge or practice for the industry sector concerned. Neither will R&D include any activity that is not intended to lead to a scientific or technical advance or which did not break new ground intended to lead to substantial improvement for the business's products, processes or services.

13.

Experimental development falls within R&D, but commercial development, including pre-production development and product development is outside R&D. There may still be difficulties in distinguishing these activities. The basic rule is to look at the primary objective of the work undertaken. If the primary objective of the development is to test the viability of the R&D, or to make further technical improvements on the product or process, then the work comes within the definition of R&D (subject to the basic requirement that R&D has to include an appreciable element of novelty). On the other hand, further development is not R&D if the product, process or approach is substantially set, or the technological uncertainty has been resolved, even though the development may be related to the design or bringing on of a product. Similarly, pre-production planning, or work to get a production or control system working smoothly is not R&D. Thus, R&D would include novel work which draws on or creates a new source of knowledge which might lead to the breaking of new ground or a technical advance and which might subsequently entail the creation or development of a new or substantially improved product, process or service.

14.

This means that work on the periodic updating or modification of a product will not be R&D if it does not involve an appreciable element of innovation and does not break new ground. However, a programme of R&D may result in incremental improvements to a product, service or process.

15.

The commercial development of a product may start before all the technical uncertainties have been resolved. In this situation, although activities directed towards commercial exploitation will not be R&D, related activities carried on primarily to resolve continuing technological uncertainties would still count as R&D if they contain an appreciable element of novelty. Similarly, new technical problems may emerge after a new product or process has been turned over to production, and the resolution of these problems may require new R&D to be carried out. However, the detection of faults in, or the modification of equipment or processes will normally involve minor modifications of standard equipment or processes and this will not be R&D.

16.

Normally research in the humanities and social sciences is excluded. But it is recognised that some aspects of the fields of natural or applied science require consideration be given to the humanities, for example the development of effective man-machine interfaces in virtual reality, or ergonomic considerations for new forms of communications. Where such research forms an integral part of the natural or applied R&D it may be included.

17.

It therefore follows that the activities in SSAP13 listed in paragraph 7 above will be R&D if they are carried on as, or as part of a scientific or technological investigation, or as pre-production development, to break new ground and increase knowledge or resolve technological uncertainty. Similarly, the activities from SSAP13 listed in paragraph 8 will not be R&D.”

The DTI Guidelines specifically deal with the development of computer software as an aspect of R&D between paragraphs 21 and 28 as follows:-

“Software

21.

Software may qualify in two respects: (i) as the object of the R&D and (ii) as the means to achieve the R&D. Software should be given equal treatment to other forms of technological activity. That is to say, for a project to be classified under case (i) as 'a software R&D project' it must seek to achieve a scientific and/or technological advance, and the whole or part of a project to resolve scientific and/or technological uncertainty on a systematic basis.

22.

Software R&D might include investigations in such areas as theoretical computer science, new operating systems, new programming languages, significant technical advances in algorithms, new or enhanced query languages, or object representations, software engineering methodologies for improved computer programmes and artificial intelligence. In this context, artificial intelligence might cover technical advances in such areas as machine vision, robotics, expert systems, neural networks, the understanding of natural language and automatic language translation. The development of, say, a new natural language interface for a computer game could qualify as R&D, although the game may be a mature product and represent non-R&D activity in most other respects.

23.

Even so, software-related activities of a routine nature are not considered to be R&D. Such activities include work on system-specific or programme-specific advancements, which were publicly available prior to the commencement of the work. Technical problems, which have been overcome in previous projects on the same operating systems and computer architecture, are excluded as are activities such as:

•

supporting existing systems;

•

converting/and or translating computer languages;

•

adding user functionality to application programmes;

•

de-bugging of systems;

•

adaptation of existing software;

•

preparation of user documentation.

24.

These do not involve scientific and/or technological advances, and are not classified as R&D.

25.

Software based, case (ii) projects involve the development or use of software within a larger R&D project. There may be no technical advance to the software per se, but the software element of the project may still qualify as R&D, if the nature of the application includes a significant degree of novelty.

26.

For example, a project to develop a new product using virtual reality simulation and computer aided engineering is most likely to use an existing computer aided engineering (CAE) package and simulation software. This would not constitute an advance to the software. However, experimental development directed towards producing a new product/process or a substantial improvement to an existing product/process aided by such computer software may still constitute R&D.

27.

Software based R&D activities of this kind will be wide ranging. They may, for example, entail experimentation in the design of new drugs, or the development of novel aerospace concepts. The use of existing computer software and finite element analysis to simulate say the aerodynamics or fluid dynamics and strength of a new vehicle, aerofoil or structure is unlikely to involve software R&D. However, the underlying research, design and development programme in these areas involving theoretical simulation, experimentation and the correlation of one with the other could.

28.

Software development intended for the analysis of, for example, market research data, which was not expected to result in the development of a scientific advance to the software, such as a new algorithm, would not be considered R&D.”

Under the heading “Qualifying Indirect Activities” the DTI Guidelines provide at paragraph 29 as follows:-

“Qualifying Indirect Activities

29.

Supporting activities that will qualify if part of a larger R&D project are:

•

scientific and technical information services, insofar as they are conducted for the purpose of R&D support (such as the preparation of the original report of R&D findings);

•

indirect supporting activities such as maintenance, security, administration and clerical activities, and finance and personnel activities, insofar as undertaken for R&D;

•

certain ancillary activities essential to the undertaking of qualifying R&D (e.g. taking on and paying staff, leasing laboratories and maintaining research and development equipment including computers used for R&D purposes);

•

training required to directly support an R&D project;

•

research by students and researchers carried out at universities;

•

research (including related data collection) to devise new scientific or technological testing methods, survey methods or sampling methodologies;

•

feasibility studies to inform the strategic direction of a specific R&D activity.”

An issue arises under paragraph 21 of the DTI Guidelines which it is convenient to deal with at this point. This relates to the question whether the operations of BES were capable of falling under both sub-paragraphs (i) and (ii) of paragraph 21 or under sub-paragraph (i) only. In my judgment this issue is to be determined in accordance with the submissions of Mr Pilling for S&W namely that they are only capable of falling within sub-paragraph 21(i). I arrive at this conclusion having particular regard to paragraphs 25, 26 and 27 of the DTI Guidelines. It seems to me clear that the commercial purpose of BES is the production of software for use by its clients in various forms of hardware such as computers of different kinds, mobile telephones etc, to which I will hereafter refer as “platforms”. The particular object which BES was seeking to achieve was to adapt the software which it had for sale so as to make its content, the computer game, simultaneously interactive by a number of users each using any of the various platforms currently available to the public. The evidence indicates that in 2000 and 2001 they were in the forefront of achieving this objective. However the objective was therefore to produce a better form of software whereby users could partake interactively in games available from BES or which they had been commissioned by outside clients to produce. This was not the novel use of software in the process of experimentation for the purpose of such things as “the design of new drugs or the development of novel aerospace concepts”. The objective was the production of a better sort of computer software with which to purvey interactive computer games to the public.

At paragraph 27 of his written opening submissions Mr Pilling summarises the effect of section 837A of the 1988 Act and of the Revenue Regulations and the DTI Guidelines made under that section as follows:-

“27.1

A project may involve an activity which constitutes R&D, as well as other activities which do not. Only the actual activity which involves R&D is treated as R&D for the purposes of the tax regime. The project as a whole does not take on an R&D character just because one element within it involves R&D.

27.2.

Activities based upon the use of well-established products or processes are not R&D. It does not matter that they are new to the user.

27.3.

Any activity that is not intended to lead to a scientific or technical advance or which did not break new ground intended to lead to substantial improvement for the business's products, processes or services does not constitute R&D.

27.4.

Commercial development, including pre-production development and product development, does not constitute R&D.

27.5

For a project to develop software to constitute R&D it must seek to achieve a scientific and/or technological advance, and form the whole or part of a project to resolve scientific and/or technological uncertainty on a systematic basis.”

I accept Mr Pilling’s paragraph 27 as an accurate summary of the effect of that legislation.

Under the heading “Tax relief for expenditure on research and development” section 69 of the 2000 Act provides as follows:-

Part I provides for entitlement to relief…”

Under the heading “Entitlement to R&D tax relief” schedule 20 provides at paragraph 1:-

“1(1) A company is entitled to R&D tax relief for an accounting period if-

(a)

The company qualifies as a small or medium sized enterprise in the period (see paragraph 2), and

(b)

The company’s qualifying R&D expenditure (see paragraph 3) deductible in that period is not less than –

(i)

£25,000, if the accounting period is a period of 12 months, or

(ii)

Such amount as bears to £25,000 the same proportion as the accounting period bears to 12 months…”

Paragraph 2 deals with the meaning of small and medium sized enterprises which is not in issue in this judgment. Under the heading “Qualifying R&D expenditure” paragraph 3 provides:-

“3.-(1) For the purposes of this Schedule “qualifying R&D expenditure” of a company means expenditure that meets the following conditions.

(2)

The first condition is that the expenditure is not of a capital nature.

(3)

The second condition is that the expenditure is attributable to relevant research and development (see paragraph 4) directly undertaken by the company or on its behalf-

(4)

The third condition is that the expenditure is incurred-

(a)

on staffing costs (see paragraph 5), or

(b)

consumable stores (see paragraph 6),

or is qualifying expenditure on sub-contracted research and development (see paragraphs 9 to 12).

(5)

The fourth condition is that any intellectual property (see paragraph 7) created as a result of the research and development to which the expenditure is attributable is, or will be, vested in the company (whether alone or with other persons).

(6)

The fifth condition is that the expenditure is not incurred by the company in carrying on activities the carrying on of which is contracted out to the company by any person.

(7)

The sixth condition is that the expenditure is not subsidised (see paragraph 8).”

“Staffing costs” in paragraph 3 are defined in paragraph 5 as follows:-

“Staffing costs

5.-(1) For the purposes of this Schedule the staffing costs of a company are

(a)

the emoluments paid by the company to directors or employees of the company, including all salaries, wages, perquisites and profits whatsoever other than benefits in kind;

(b)

the secondary Class 1 national insurance contributions paid by the company; and

(c)

the contributions paid by the company to any pension fund (within the meaning of section 231A(4) of the Taxes Act 1988) operated for the benefit of directors or employees of the company.

(2)

The staffing costs of a company attributable to relevant research and development are those paid to, or in respect of, directors or employees directly and actively engaged in such research and development.

(3)

In the case of a director or employee partly engaged directly and actively in relevant research and development the following rules apply

(a)

if the time he spends so engaged is less than 20% of his total working time, none of the staffing costs relating to him are treated as attributable to relevant research and development;

(b)

if the time he spends so engaged is more than 80% of his total working time, the whole of the staffing costs relating to him are treated as attributable to relevant research and development;

(c)

in any other case, an appropriate proportion of the staffing costs relating to him are treated as attributable to relevant research and development.

(4)

For the purpose of sub-paragraphs (2) and (3) persons who provide services, such as secretarial or administrative services, in support of activities carried on by others, are not, by virtue of providing those services, to be treated as themselves directly and actively engaged in those activities.”

“Expenditure on consumable stores” is defined in paragraph 6 as follows:-

“Expenditure on consumable stores

6.-(1) For the purposes of this Schedule expenditure on consumable stores means expenditure that would be treated as expenditure on consumable stores in accordance with normal accounting practice.

(2)

Expenditure on consumable stores is attributable to relevant research and development if the stores are employed directly in such research and development.”

It is convenient at this point to deal with a further issue. It is submitted by Mr Reza on behalf of BES that the provisions of paragraph 29 of the DTI Guidelines justify an application for R&D relief in respect of expenses incurred in respect of activities supporting operations which themselves qualify as R&D which are not confined to “Staffing costs” or “Consumable stores” under sub-paragraph 3(4), or paragraphs 5 and 6 of schedule 20. I do not understand there is any issue as to what comprises “consumable stores”. These must be such things as fuel, ink, or paper actually used in the process of R&D.

The issue arises over the claim for R&D relief in respect of “recruitment fees” incurred in the recruiting of staff shown on the schedule appearing at page 10 of BES’ letter of the 26^th June 2002 to the Inspector of Taxes. It is accepted that these fees cannot fall within “staffing costs” for the purposes of paragraph 5 of schedule 20 to the 2000 Act since they do not comprise “emoluments paid by the company to directors or employees”, National Insurance contributions or contributions to any pension fund within sub-paragraphs (a) to (c) of paragraph 5(1). It is, however, submitted for BES that they can be claimed because they fall within paragraph 29 “qualifying indirect activities” of the DTI Guidelines. In particular they fall within the third bullet point of paragraph 29 “certain ancillary activities essential to the undertaking of qualifying R&D e.g. taking on and paying staff…)”.

I reject that submission for the following reasons:-

It follows from this analysis that, to the extent that the Revenue made payments or otherwise allowed relief for expenditure by BES in respect of recruitment fees they were not, in my judgment empowered to do so.

I turn to consider whether BES has at any relevant time spent money which is qualifying R&D expenditure within schedule 20 to the 2000 Act, in particular, which falls to be treated as “Staffing Costs” within paragraph 3(4)(a) as defined in paragraph 5 of the schedule. The issue to be considered is whether such expenditure constitutes “emoluments”, secondary class one National Insurance contributions, or contributions to any pension fund paid by BES to directors or employees of BES directly and actively engaged in qualifying R&D for the whole or part, being more then 20%, of their working time.

The burden of proof rests on BES to prove that it has suffered damage as a result of S&W’s breach of duty. It is a necessary part of discharging that burden that BES satisfies the court that it was originally entitled to receive R&D tax relief. The extent of that burden is subject to the point made on behalf of BES, that BES is hampered in discharging it by the fact that, because S&W failed to inform it of the existence of R&D tax relief until April or May 2002, after the company had been mothballed, they do not have any records of precisely which employees were engaged in R&D work, what was the nature of that R&D work, and what proportion of their working time was spent on that work. It is submitted by BES that this absence of records flows directly from S&W’s admitted breach of duty.

I have already set out the legislation 2^nd guidelines which now define what constitutes R&D and have accepted Mr Pilling’s summary of their effect. The case concerns computer software R&D further defined by paragraphs 21 to 28 of the DTI Guidelines. I have held that any relevant expenditure must fall within case (i) of paragraph 21. It is submitted by Mr Pilling, and I accept, that the fundamental definition of software R&D falling within case (i) is contained in the following words from paragraph 21 of the DTI Guidelines:-

“… for a project to be classified under case (i) as “a software R&D project” it must seek to achieve a scientific and/or technological advance, and form the whole or part of a project to resolve scientific and/or technological uncertainty on a systematic basis.”

The question therefore is whether BES have adduced sufficient evidence to show that, at any relevant time, BES was engaged in such a project and, if so, which employees were so engaged and for what proportion of their working time.

Mr Pilling drew my particular attention to paragraph 10 of the DTI Guidelines and the requirement that “R&D should be founded on the investigation and exploitation of a scientific principle. This may be in pursuit of the creation or development of, for example, new liquids, substances, materials, software, designs, products, processes, technology or knowledge”. I accept that the word “this” starting the second sentence of the above quotation from paragraph 10 must refer to the “investigation and exploitation” in the previous sentence. I also accept his submission that the words “directly and actively engaged” in such research and development in paragraph 5(2) of schedule 20 means that for the staffing costs of a particular director or employee to qualify for relief he must be actively employed in the research and development process and not in a supporting role such as management.

As the pleadings in the case make plain the key issues at the trial were going to be, and were: (1) what BFS was actually doing which was said to constitute R&D; and (2) which members of its staff were engaged in those activities and for how much of their working time. Whether or not S&W can be blamed for the fact, it remains the case that BES does not appear to have kept any systematic record of what work its staff were engaged in from day to day. In any event no example of such a record was produced in evidence. During the Spring of 2001 BES’ staff were asked to complete self-appraisal forms in which they were asked to describe their role and what they regarded as their own strengths and weaknesses and those of BES itself and its management. Copies of these self-appraisals were in evidence and are very revealing. There are also contemporary documents in evidence which show the production schedules for some of the individual projects undertaken by BES in the course of its active life. BES’ witnesses who attended the hearing and were cross-examined were as follows:-

Mr Evans gave a witness statement and was intended to attend the trial for cross-examination. He did not do so but his witness statement was put in, with my permission, under the Civil Evidence Act.

In his closing written address for S&W, Mr Pilling makes the following submissions:-

“3

It is … remarkable that the Claimant’s witness evidence made virtually no attempt to address either of these questions. No evidence was led which identified what the Claimant was actually doing which constituted R&D. Those witnesses who touched on this subject in their statements did so fleetingly, and in determinately non-specific terms. No evidence was called from any of the employees who were supposedly engaged in R&D. Most of those employees did not even get a mention in the witness statements of those witnesses who were called.

4

What emerged from the evidence is that both the Claimant’s factual witnesses and its expert witness, Mr Owen, have made an assumption that because they believed that the Claimant’s products were in some general sense “innovative” or “cutting edge” it therefore follows that they were the product of R&D within the meaning of the statute….

5

It is submitted that this bare assumption was not a sufficient basis upon which to advance a claim for R&D tax credits to the Inland Revenue, and neither is it a sufficient basis to advance a claim for damages against the defendant.”

I have to say, straight away, that I accept Mr Pilling’s submissions. My reasons for arriving at that conclusion involve an examination of the evidence of those of BES’ staff who gave evidence and what is known or can be deduced from their evidence and from the documentary evidence about the role and work performed by the other members of BES’ staff who were not called.

I turn therefore to consider the evidence of Mr Price who, it will be remembered, was a director of LF Consulting Group Ltd who first appeared on the scene in April 2001 to assist BES in the production of the information memorandumand who later prepared BES’ application for R&D tax relief after it had become aware of the availability of such relief. It has to be said that Mr Price came closest to trying to describe the R&D work allegedly being carried on by BES in terms which were referable to the definition of software R&D contained in the DTI Guidelines. In the sub-paragraphs of paragraph 10 of his first witness statement Mr Price sets out the technological objectives which he understood BES was pursuing and, at paragraph 11 how they were attempting to achieve that as follows:-

“10.1

The creation of software code that would allow the Claimant to provide a truly interactive user experience in real time, potentially to multiple users worldwide, which would not only provide users with infinitely more choices within the course of their interaction, but would also be platform and geographically independent and capable of providing advertisers with real time access to users through the software interface without detracting from the users entertainment experience, a seamless marrying of entertainment with commerce, something which to my knowledge has still not been achieved in the current market.

10.2

The need to understand how new software could make the best use of emerging delivery platforms such at 3G, ISDN (as it then was), broadband and inter-active television.

10.3

Dealing with new technology for accessing the delivery platforms and delivering content through set top boxes, consoles, mobile telephones.

10.4

How to deal with the alternative application programming interfaces within the new interactive television environment.

10.5

The point was that the claimant was not merely tryingto use the new faster platforms to deliver existing software they were looking to extend the view of traditional software to make full use of the faster delivery platforms and the increased market that this would ultimately create.

11

As far as I am aware the Claimant was not only seeking technological advances in the fields of software programming, but that in doing so they were attempting to resolve uncertainty that existed in relation to the ability to create a programming language and user interface that would answer all of the issues referred to by me above. The very concept which was promoted by the Claimant would have created a product which contained appreciable improvement over existing entertainment software, and which represented an increase in overall knowledge in relation to its interactivity and ability to marry commerce and user functionality into the software.”

Mr Price makes a second attempt at doing so where he gives “some examples of the innovation creativity and uncertainty that the Claimant were [sic] dealing with” at the sub-paragraphs to paragraph 17 of his second witness statement as follows:-

“(i)

The novel and innovative aspect of the Claimant's work was in attempting to link entertainment to real life on demand advertising and commercial delivery, something which is only now, some four years' later, being attempted by some of the larger international corporations. As an example, Sony has recently produced a game which enables players to order pizza interactively without leaving the playing area. It is within my knowledge from discussions with CD [Mr Dickens] that the Claimant was working on this in 2000 and 2001, with a far greater degree of complexity than has been actually delivered in the Sony solution;

(ii)

In paragraph 12 of Ted Evans’ witness statement of the 13^th December 2004, he includes a description to the "Game Engine" that was being worked on. Whilst this engine could be used as the underlying basis of any number of core products once it was completed, the period until it was prototyped, trailed and put into operation would all count as development. Since the Claimant and more specifically Mr Evans, with his significant background in this industry, felt that there was a need to create such a Game Engine as there was no available product on the open market this I believe clearly places the work in the innovative and resolving of uncertainty category;

(iii)

A third area that the Claimant began work on was in the resolution of uncertainty relating to platform independence. There were clearly huge market advantages to being able to deliver the same product through different platform media with minimal coding changes, to my knowledge no existing supplier has resolved this issue.”

In cross-examination Mr Price was asked to identify what scientific or technological breakthrough was involved in such “innovation, creativity and uncertainty” by reference to each of the sub-paragraphs and he was compelled to answer that he could not do so because he lacked the technical background and knowledge.

In the course of his cross-examination-in-chief Mr Price asserted that the objective of BES’ staff was to develop a “chassis” or underlying technical infrastructure which would be part of future products and would enable them to be received and to be operated interactively on all available platforms. He was compelled, however, in cross-examination to accept that this assertion was inconsistent with a passage on the first page of the Information Memorandum which he had assisted in producing. Unless this “chassis” is the same product as the “game engine” referred to in sub-paragraph (ii) in the above quotation from Mr Price’s second witness statement, this was a new suggestion which had not appeared before in any part of BES’ case nor in any document in evidence. When Miss Berry gave evidence she adhered to the account of BES’ operations contained in the Information Memorandum and subsequently, by BES’ counsel, a case based on the development of the “chassis” was disavowed.

The basis upon which Mr Price prepared BES’ claims for R&D tax relief is well illustrated at paragraph 16 of his second witness statement where he describes how, in conjunction with Mr Dickens, he split the activity of BES between that which was capable of constituting R&D and that which was not in the following way:-

“16

Once I had accounted for the commissioned work [i.e. development work commissioned by outside clients, the fruits of which would belong to those clients and not qualify for relief] and estimated with [Mr Dickens] the percentage of non-R&D such as the administration, sales and marketing, the remainder of the work was clearly in my mind research and development.”

In the course of his cross-examination on 10^th May (transcript page 88) Mr Price was asked “turning to the process of putting that R&D claim together, can I summarise what I believe your approach was, and you can tell me if I have understood it correctly. Your approach was to assume that unless you could identify otherwise, everything that the claimant was doing was research and development within the medium of the legislation and therefore, you deducted from the totality of the relevant expenditure an amount to account for commissioned work, where the IPR was not to be retained by the claimant, and an amount to account for administration, sales and marketing exercises. Is that correct?” to which the answer was “yes”. Mr Price accepted that he could have consulted Miss Berry or Mr Evans to tell him the nature of the work that was being undertaken but did not do so. Nor did he consult BES’ surviving documentation, some of which, as I will later discuss, was illuminating.

I accept Mr Pilling’s submission that this approach to the preparation of a claim for R&D tax relief was entirely inappropriate because it is based on the supposition that, because BES was producing, by means of the software that they had developed, computer games and other products which permitted uses not, at that time, achieved by any other competitor, then any work undertaken by any of its staff which was not commissioned work and was not involved in administration, sales and marketing, must have been qualifying R&D.

I turn to the evidence of Mr Evans which is confined, for the reasons which I have already given, to the text of his witness statement and should be treated with a caution which reflects the fact that it has not been tested in cross-examination. It was accepted, however, that, apart from the two programmers, Mr Evans was the only BES witness who had any grasp of computer technology, although even he had not received any formal training in that subject. Mr Evans describes the objectives which his company was seeking to achieve in paragraphs 6 to 10 of his witness statement as follows:-

“6.

I felt that the Claimant was “ahead of the curve” because we were developing cutting edge interactive entertainment software that performed well even with the speed limitations of European Internet access at the time. But the key to the Claimant's future prospects of success was the development and marketing of interactive entertainment products for distribution via interactive TV and mobile which would require the development of software that was not available in the market.

7.

At the time, we were working in a market where there were few competitors. There were only two or three companies with any real significance trying to tap into the same market. As Creative Director of the Claimant I visualised the development of the interactive entertainment market from Internet and Broadband based distribution to more lucrative platforms such as interactive TV and mobile phones. In order to exploit these new platforms it would be necessary to develop new techniques not only to deal with the new platforms which had not previously had software written for it, but also to fully exploit the potential speed and interactivity of the new platforms:

•

To create huge playing arenas that would not be bound by geographical or platform based restraints. Players using mobile phones in the US could interact with those in Asia using a television, without connection problems or delays in transmission.

•

To remove the limit on the number of players able to participate.

•

To provide a level of interactivity between the players that it would be almost impossible for any one player to share their storyline with another, since their outcome would dependupon the interactions that they had, not only with the software but also other players.

•

To create backgrounds that were so rich and diverse that they could be comparable with big budget film productions.

8.

In addition to the user benefits and through the business contacts of my fellow Directors they had highlighted a new and potentially lucrative revenue stream making use of the new platforms speed, through the inclusion of supplier funded advertising within the main interactive entertainment product. It was development in this area which the Claimant was undertaking with a view to capitalising on the new markets by:

•

Seamlessly linking supplier commerce activities interactively into the interactive entertainment product.

•

Providing suppliers with a captive global market.

•

Providing suppliers with real time data about the products being purchased, by market, age group and gender.

•

Allowing players to deal with real life issues whilst maintaining their entertain activity.

•

The closest that anyone has come to achieving real time interaction between suppliers and entertainment in the UK is through the red button on Sky Digital to place a pizza order during a commercial break.

9.

In order to achieve the advances for the player and the supplier, it would be necessary for the developed software to be platform independent, which would require an investment in developing the application programming interfaces to link the platforms, as well as the difficulties in delivering the new interactive entertainment products through various devices, telephones, television, consoles etc. Even today no software manufacturer has been able to seamlessly link all of these elements together to provide one single solution.

10.

Due to lack of available funding and the subsequent mothballing of the activities of the Claimant, the work undertaken in trying to achieve this project was never completed. ”

Mr Evans nowhere describes any new scientific or technological development achieved by BES’ staff which enabled BES to be “ahead of the curve” in developing interactive computer games and other products. This could have been achieved by the use of existing computer technology.

I turn to the evidence of Miss Berry who, as the managing director at all material times, was the only witness to give oral evidence who was able to describe the operations of BES during such time. Miss Berry was cross-examined with reference to paragraph 22 of the DTI Guidelines which I have set out above. Her answers are recorded in the transcript for the 12^th May between pages 113 and 119. I accept Mr Piling’s summary of those answers at paragraph 44 of his written closing submissions where he says “she did not know whether the claimant’s employees were working in the field of theoretical computer science; making significant technical advances in algorithms; working on new or enhanced query languages or object representations; machine visions; or expert systems. She confirmed that they were not developing new operating systems, creating new programming languages, working on artificial intelligence, neural networks, automatic language translation, or a new natural language interface. She said that she thought that they were working on creating new software methodologies for improved computer programs, but was unable to identify any specific employee involved in such work, the name of any new methodology created by the claimant, or the project reference or project number ascribed to any effort to produce such a methodology.”

Miss Berry’s answers highlighted the fact that she did not herself have the technological expertise with which to answer the questions, and in particular, she was not able to describe any scientific or technological innovation or breakthrough which BES staff were trying to achieve or had achieved.

Miss Berry’s cross-examination also highlighted, in part by reference to particular projects that BES had undertaken, that the production of a computer game available for sale to the public required a number of stages involving the conception or acquisition of the idea for the game, planning, scriptwriting, drawing and designing backgrounds and characters, creating animated sequences and soundtrack and, finally, programming the result of all these. None of these activities without more necessarily involve qualifying R&D.

Mr Pilling drew my attention to Miss Berry’s answers to Mr Price’s questions contained in a memorandum of 25^th April 2001 namely “(b)how does [sic] the creative skills split down between concept development, scripting, design, art production, audio production, motion production and technical production?” and “(c) does the technical team above perform any of the development work outside of the computer environment?”. Her answers were:-

“(b)

Concept development – everyone

Scripting mainly Ted [Evans] with help from Neil [Merrick one of the two programmers] and outside writes dependent upon product.

Design – Ted sets style guide, rest of creative follow it.

Art production – whole creative department

Audio- Ted and outside contributors (friendly contacts who are v good and v cheap)

Motion – Jay [Merry], Matt [Dyke] under Ted’s guidance.

Technical production- what do you mean here? If you are including programming in the Creative time – which would be confusing – then Yura [Nalepa the other programmer] and Neil with Ted’s support.

(c)

Again technical team – do you mean creative team, programmers or the two together anyhow, creative programming and production all also do photo shoots, amateur voiceover and acting if required, story boarding, brainstorming – lots of other stuff.”

Miss Berry in cross-examination confirmed that those answers were accurate.

It is common ground that the only members of BES’ staff with the technological training and background to undertake the sort of work which might qualify for R&D tax relief were the programmers Mr Merrick and Mr Nalepa. This answer presents a picture of programmers being used for work which is plainly not qualifying R&D – Mr Merrick being used to assist with scripting. “Technical production” might involve qualifying R&D but by no means necessarily does. Miss Berry accepted under cross-examination that BES “did not have in-house the skills required to create or reconfigure the programs to work on some new interactive TV platforms” in April 2001.

It was accepted by BES’ witnesses that when Mr Evans moved to Flextech after the mothballing of BES and there completed the development of a number of projects which had been started by BES, Flextech was not required to make any payment to BES for the use of any technological know-how he had acquired at BES and which, if original, one would have expected to have been protected by patent. Indeed there was no evidence that BES had taken out patents in respect of any technological advances which had put them at the “leading edge” of the development of interactive computer technology.

In BES’ claim for R&D tax relief for the year 2000 (“the first claim”) it was asserted that 25% of Miss Berry’s time had been spent on qualifying R&D. In the claim for the year 2001 (“the second claim”) it was asserted that she spent 34% of her time on qualifying R&D and in the claim in respect of 2002 (“the third claim”) it was asserted that 30% of her time was so spent.

Miss Berry deals with the question of her contribution to the R&D effort of BES at paragraphs 25 and 26 of her witness statement as follows:-

“25

I have now seen a submission made on BE Studios' behalf to claim research and development costs. By the time this submission was made I had left BE Studios and I took no part in the submission. I have no recollection of being consulted on its contents. What I can, however, say from my personal knowledge is:

(a)

a very considerable amount of research and development was carried out by BE Studios to enable it to compete in the market and produce the products it did. Some of our work was completely innovative, for example, in relation to Cypher, this started life as a CD and it moved from that to a Web-based product and then was reconfigured into an interactive TV product. This I believe was the first time any such conversion had taken place and was simply only achieved by breaking new grounds in technology and development;

(b)

the actual title of various people at the Claimant was largely irrelevant. There were no demarcations and people carried out the work as was necessary even though various people had their own specialist areas. It was also inevitable that assessments would have to be made at the percentage of time people spent on research and development. One month a person might be engaged full-time and another month not at all;

(c)

in relation to my part, although my position was Managing Director, inevitably I became involved in research and development as well. I do not know the basis on which the 34% figure was put but I can say a significant part of my time was spent on research and development matters;

(d)

I was never contacted by Smith & Williamson at any stage to discuss questions of research and development, although as I have said above I would not have been the most likely person to have been contacted for accountancy purposes, I would have been able to provide any information had they needed the same.

26

In creative terms, another a good example where research and development arose would be Crepe de Chine. This was a period (1920s) series, of which we made six episodes and had every expectation of making another six. Each scene involved the creation of a set in a room in a Parisian house. To do this, on the creative side, we had to research clothes, and furniture of the 1920s and obtain images of the same. Each scene in Crepe de Chineinvolved the marrying of up to a dozen created images to produce the end result. The Claimant won a number of awards for work on this and other projects.”

Miss Berry’s description at paragraph 26 of the work involved in the production of “Crepe de Chine” clearly does not involve qualifying R&D. When she was asked to identify a scientific or technological uncertainty to the clarification of which she had in any way contributed, Miss Berry was unable to do so.

I now turn to deal with what is known from the evidence about the work performed by other members of BES staff who were not called to give evidence.

I start with Mr Neil Merrick. It was asserted that he spent 90%, 88% and 90% of his time on qualifying R&D in the first, second and third claims respectively.

Mr Merrick is not mentioned in any of the claimant’s witness statements. Under cross-examination Miss Berry said that she thought Mr Merrick spent more than 20 % of his time on commissioned work thereby invalidating each of the claims for R&D relief made in respect of him. I have already noted how Mr Merrick is described in a contemporary document as being employed on work other than that of programming. Miss Berry’s evidence was that he spent 5 to 10 % of his time writing scripts and 10% of his time in activities such as “storyboarding and brainstorming”. Mr Merrick wrote a personal appraisal which is in evidence in which he describes himself as “Senior Programmer: My duties are to write the backend coding for all the products we create”.

Mr Merrick’s self-appraisal form contains no mention of any activity that would seem to comprise qualifying R&D activity as Miss Berry accepted in the course of her cross-examination. Miss Berry was concerned to try and play down the evidential value of the self-appraisals, such as that produced by Mr Merrick, which is undated but I would assume to have been written contemporaneously with the other examples that is in about May 2001. She was concerned to emphasise that it was typical of “talented” staff, such as those on the books of BES, to be complaining about the work that they were doing and wishing to be employed differently.

I turn to Mr Yura Nalepa the second programmer. It was asserted that he spent 75%, 95% and 96% of his time on qualifying R&D in the first, second and third claims respectively.

Like Mr Merrick, Mr Nalepa is not mentioned in any of the claimant’s witness statements. In cross-examination Miss Berry stated that he spent 5% of his time carrying out on-site support and network administration and 10% of his time on activities such as storyboarding and brainstorming. She said that he spent between 20% and 75% of his time on commissioned work. None of these activities would qualify for R&D relief. Miss Berry’s evidence therefore invalidates each of the claims in respect of Mr Nalepa.

Mr Nalepa completed a personal appraisal form. By contrast with Mr Merrick the majority of the form describes his technical work as a programmer although he gives himself the job title of Senior Developer. Nowhere in his description of the work that he is doing does there appear anything that would qualify for R&D relief as Miss Berry accepted.

Leila Balzer: It was asserted that Miss Balzer spent 95% and 100% of her time on R&D in the first and second claims. She does not figure in the third claim.

She is mentioned in Miss Berry’s witness statement where she says that Miss Balzer “spent time ensuring that current work was done to time and to budget and selling the services of the claimant.” There is no evidence-in-chief of how it is said she performed qualifying R&D work. Under cross-examination Miss Berry described Miss Balzer as a project manager involved in managing the full spectrum of activities carried out by the claimant’s staff. Miss Berry said that 20% of her time was spent marketing the claimant’s products and developing new business. It follows from this that part at least of her remaining time must have been spent managing the production of commissioned work.

In my judgment management services do not qualify for R&D tax relief because managers are not “directly and actively engaged in such research and development”: see paragraph 5(2) of schedule 20 to the 2000 Act. Even if that conclusion is wrong, if there is no evidence that any of the other staff were engaged in qualifying R&D work Miss Balzer who may have managed them cannot have been doing so either. Miss Balzer did not complete a self-appraisal form.

Collette Potter: It was asserted that Miss Potter spent 90%, 88% and 85% of her time on qualifying R&D in the first, second and third claims respectively.

Under cross-examination Miss Berry accepted that Collette Potter’s background was as production coordinator for the Edinburgh Festival. The nature of her work was similar to that of Miss Balzer with between 30 and 40% of her time spent on sales marketing and business development activities. Thus Miss Berry’s oral evidence immediately invalidates the claims made in respect of Miss Potter. My above conclusion in relation to Miss Balzer that management work does not qualify for R&D relief applies to Miss Potter and even if wrong she would still not qualify unless managing staff who were shown to be engaged on qualifying R&D work. Miss Potter completed a self-appraisal form which is consistent with Miss Berry’s evidence as to the nature of her job. She is referred to in Mr Dickens’ witness statement but he, under cross-examination, was unable to identify any qualifying R&D work with which she could be associated.

Mr Jay Merry: It was asserted that Mr Merry spent 90%, 97% and 100% of his time on qualifying R&D in the first, second and third claims respectively.

Mr Merry is not mentioned in any of the witness statements of BES’ witnesses. He completed a 13 page self-appraisal in May 2001 which was in evidence. In cross-examination Miss Berry said that Mr Merry’s background was as a project manager and video producer for an audio visual company. At BES his job title was “Senior Designer” . Mr Merry’s description of his role contained in his self-appraisal is as follows:-

“With my hand on my heart I could say that I have yet to “design” anything. I have had small art roles within the products that we have created but on the whole my contributions to the work have been time and people management and low level admin/donkey work (sourcing images, scanning images, cleaning up art, etc).

I have broken down my roles in three of our products to show what I feel I contributed: -

Crepe de Chine – Opening videos and initial creation of rooms 4 through 6. On the whole in Crepe de Chine I created the majority of episode openers (videos), assisted with audio and sourcing the images used in the rooms. Matt and I decided to create the rooms 4 through 6, we submitted the rooms to Ted and Gerry to finish off, (this proved to save time for them and made Matt and I felt we had helped create the look and feel of those rooms).

70% Creative - 30% admin / donkey work.

Panopticon - This prototype happened as Ted was leaving for a long trip (two weeks I think) to America, I took on the mantle of Project Manager and creative director.

During this time we had been left with a style guide from Ted and a page of loose brainstorm ideas. I did very little production on this, I supervised and project managed the design team and dealt with several staff issues but actually had minimal design input past the brainstorm. I worked on the transitions into the body's art wise but mainly admin like organising photo shoots etc.

90% Admin - 10% Creative.

Nosy Records - Again minimal creation outside of ideas in the brainstorm. This job I was given the role of “Directorising” (to put work into the program Macromedia Director for a playable demo, this allows you to click through and understand how the finished product will look).

However I was not given the job to make the piece functional (scripting, a programming language in Director that I have been doing for years), so as to make the piece have buttons, links and animation. Ted wanted the programmers to understand how director worked so my job was simply to place art work into the program and hand it off to the programmers. 90% not involved - 10% donkey work.

So I don't know what my position is in the company but it certainly isn't “Senior Designer”.

What you contribute to B.E:

What I contribute to B.E. and what I should contribute to B.E. are two entirely different things. Currently I am used for low level design team management and creating and inputting text on proposals for “new games”.

What I thought I would contribute when I took this job was design ideas, concept ideas, PhotoShop work, teaching, client liasing, assisting at meetings, hands on production and using my previous knowledge.”

Miss Berry in cross-examination said that Mr Merry’s account of the job he was performing was inaccurate. She said that what Mr Merry described as that which he would like to do, namely, to work on design ideas, concept ideas use Photoshop (an art software application), teach (other members of staff) liase with clients assist in meetings, do hands on production work using his previous knowledge, was what Mr Merry actually did. Miss Berry could not say whether his estimate of the split of his time working on the “Crepe de Chine” project was correct. She said his estimate for the “Panopticon” project was inaccurate but did not suggest an alternative. She thought his estimate for the “Nosy records” project was accurate.

In my view Mr Merry’s self-appraisal when read with Miss Berry’s evidence given in cross-examination does not contain any material which indicates that Mr Merry was, at any time, engaged in R&D work, let alone qualifying R&D work.

Mr Gerry Edwards: It was asserted that Mr Edwards spent 78% and 95% of his time on qualifying R&D in the first and second claims respectively. He does not feature in the third claim.

Mr Edwards is not mentioned in any of the BES’ witness statements and he did not complete a self-appraisal. Miss Berry accepted that Mr Edwards’ “activities and skills overlapped with those of Mr Merry”.

Mr Matt Dyke: it was asserted that Mr Dyke spent 90%, 98% and 95 % of his time on qualifying R&D in the first second and third terms respectively.

Mr Dyke is not mentioned in any of BES’ witness statements. Under cross-examination Miss Berry accepted that Mr Dyke’s background was in designing audio/visual presentations, experience which was relevant to his role with the claimant. In an e-mail from Mr Evans to Mr Dickens, Mr Evans says of Mr Dyke that he “also showed no interest in trying to make himself more useful by applying himself to new skills. He regards himself as a motion designer and that’s it, anything else was beneath him.” Miss Berry disagreed with this view saying that Mr Dyke had said to her that he was prepared to undertake new tasks.

Mr Dyke completed a self-appraisal in May 2001. Answering a question as to his position in the company Mr Dyke wrote:-

“At the present time I see my position as something of an admin role, whereby I am writing documents and proposals, creating flowcharts and scanning pictures. I don’t seem to have a creative role within the company at the present time and I haven’t done so for some time.”

As with Mr Merry and Mr Edwards, Mr Dyke was part of the “creative team” which also included Annette West. Mr Dyke describes those persons as forming part of the team in his self-appraisal.

Miss Berry in cross-examination did not accept that the above quotation from Mr Dyke’s self-appraisal accurately described his role. She was however unable to point to any scientific or technological investigation with which he was associated saying that “he was too busy being innovative and creative”.

Annette West: It was asserted that Miss West spent 100% and 96% of her time on qualifying R&D in the second and third claims respectively. She does not feature in the first claim. Miss West is not mentioned in any of the BES witness statements. Under cross-examination Miss Berry described Miss West’s background as five years spent in print production and design with a master degree in illustration. Her principal contribution to BES up to May 2001 was as an artist and her illustration skills were of critical importance.

Miss West completed a self-appraisal in which she says that she did 90% of the art work in the “Panopticon” project and that she regretted “that I haven’t really done enough about new programs or web technologies… I have picked up the basics and continue to learn at home, but hoped I would know more by now.”

Miss Berry accepted that Miss West was not trying to make technological breakthroughs and said that she was “too busy being creative and finding new ways to be creative”. Notwithstanding that Miss Berry, in the face of this evidence, still maintained that Miss West was in some way engaged in qualifying R&D, she did not identify any scientific or technological activity with which she was associated.

Mr Rashpal Sagoo: It was asserted that Mr Sagoo spent 90% and 98% of his time on qualifying R&D in the first and second claims respectively. He did not feature in the third claim. It was Miss Berry’s evidence under cross-examination that Mr Sagoo was part of the creative team and that his skills lay in the field of audio design. He did not complete a self-appraisal. There is no evidence that Mr Sagoo was, at any time, engaged in qualifying R&D.

Mr Geoff Jones: It is asserted that Mr Jones spent 95% of his time on qualifying R&D in the third claim. He is not mentioned in any of the BES witness statements. In a press release dated 15^th June 2001, together with Miss Anna Jones he is shown to have been recently hired as a full time illustrator. There is no evidence that he was ever engaged in qualifying R&D.

Miss Anna Jones: it is asserted that Miss Anna Jones spent 95% of her time on qualifying R&D in the third claim.

Miss Jones is not mentioned in any of the BES witness statements. In cross-examination Miss Berry accepted that Miss Jones fulfilled the same role as Miss Annette West and that her knowledge and experience were limited. Miss Berry was unable to identify any scientific or technological research with which Miss Jones was associated.

BES’ claims for R&D relief included claims in respect of costs relating to unspecified freelance workers. From the cross-examination of Miss Berry and Mr Hyde (at one point Miss Berry explained that the workers included her nanny) it emerged that the freelance workers were employed on commissioned projects, marketing or administration.

I turn to consider the evidence of Mr Owen, BES’ expert witness.

In the course of his cross-examination Mr Owen confirmed that it was his understanding that for a project to be classified as a software R&D project it must seek to achieve a scientific and/or technological advance, and form the whole or part of a project to resolve scientific and/or technological uncertainty on a systematic basis. Thereafter the following passages are to be found in the transcript of his cross-examination:-

“Q You have made an assumption that because the claimant’s products were in your… belief at the leading edge, therefore it follows that they must have been a product of qualifying research and development. That is how you had really reached your conclusion is it not?

A Yes.”

17^th May page 39 line 13.

“Mr Pilling: Mr Owen can I approach the subject in this way. You would expect, if you had been brought in to advise the claimant about the possibility of making these claims in April, May, June 2002 and Mr Price was brought in to fulfil that role. You would expect that if you said to the claimant’s officers “can you tell me what scientific and/or technological advance you think you are making, and what scientific and/or technological uncertainty the claimant is seeking to resolve on a systematic basis”, that those officers would be able to provide you with an answer would they not?

A Yes

Q Now, I have been putting to the claimant’s witnesses who have sat where you are sitting throughout this trial, the same question I have been putting to you for the last half hour: which is asking you to identify what scientific or technological uncertainty they would need to resolve. And I am still waiting for an answer to that question. Now that does not concern you, does it, as an independent expert, if the claimant’s witnesses themselves are unable to identify any technological or scientific uncertainty involved in their work.

A Well, it would have to, yes.”

I must now consider the problem posed by the admission of S&W of negligence in failing to draw to the attention of BES the fact that they might qualify for R&D tax relief under the legislation which I have set out earlier in this judgment. Had they done so the staff of BES might have been concerned to keep daily or weekly records of their time spent on work which might qualify for such relief, in particular, recording the type and objective of R&D with which they were engaged. The problems of proving any damage flowing from S&W’s admitted negligence may therefore be said to flow from the negligence itself.

I have found that there is no evidence upon which it is possible to base a claim that BES was engaged in qualifying R&D work. I have considered whether it would be possible to find that part, at least, of the working time spent by the programmers, the only members of staff who skills would make them capable of undertaking such research and development, could be treated as qualifying R&D work on the basis that the apparent leading position in the interactive computer programme field which BES apparently held could not have been achieved without some such work. I have come to the conclusion that I cannot do so for the following reasons:-

It is clear from the correspondence between BES and the Inland Revenue in which the Inland Revenue was seeking clarification of the claims for tax relief, that those inquiries were not directed to the nature of the work which was actually being undertaken by BES and which the claims represented as being for qualifying R&D. In my judgment had inquiries been made by Revenue staff into BES operations and those inquiries had revealed a picture no different from that painted by the evidence produced to this court, then the claims for R&D tax relief made by BES should have been rejected in full.

That is sufficient to dispose of this case. However since my findings of fact are based on my construction of the effects of the relevant legislation I will go on to consider, briefly, whether if my conclusion is wrong and they were entitled to receive R&D tax relief, to the full extent of the claims in respect of the years to June 2000, 2001 and 2002 and thereafter for qualifying work BES could have established that they have suffered damage as result of S&W’s admitted breach of duty.

Where a client has suffered loss as a result of negligent advice it is first necessary to determine from the contract of retainer what it was that the advisor contracted with his client to do. Did the advisor undertake to advise on whether a particular cause of action should be taken or did he undertake a duty to provide his client with correct information upon which his client would base his future actions. In the former case the advisor is responsible for all the foreseeable loss caused to the client in consequence of the actions taken by him on the basis of the negligent advice. If the duty is to supply information then the advisor/information giver will be responsible for the foreseeable consequences of the information he supplied being wrong. See South Australia Asset Management Corporation v York Montague Ltd [1997] AC 191. Contrary to the submissions of Mr Reza it seems to me to be clear that S&W fulfilled the role of an information giver. BES’ complaint is that they owed a duty to provide information as to the availability of tax relief as part of their retainer to provide BES with accounting services. The information provided was incomplete. As a result BES underestimated its income flow which led to the decision in December 2001 to dismiss BES’ staff and mothball the company. It is not suggested that BES would have been able to retain its full staff even if it had been aware as at the 30^th June 2001 of the availability of R&D tax relief. It was submitted that in the light of BES’ then prospects, including the prospects of R&D relief, the company would have dismissed the bulk of its staff, retaining a skeleton staff, but relying on the availability of freelance workers, possibly its own dismissed staff, to work on the production of any orders that it succeeded in obtaining. It was suggested that if this had been done it would have been in a position to exploit its stock of completed computer games, to complete the development of those in the process of production and to undertake any fresh work which was offered. This semi-mothballing of the company would have required additional finance which Mr Dickens would have been prepared to provide by extending the company’s overdraft up to £100,000. It was, however, accepted that for any sustained recovery it would have been necessary to obtain the support of further outside investors.

In its particulars of claim BES sets out the loss allegedly suffered as a result of S&W’s admitted negligence as follows:-

“Details of Loss

Had the Claimant been advised that it would or might be entitled to receive R&D tax credits in the amounts referred to (or thereabouts) it would or could have taken the following steps between July and November 2001 namely (a) attempted to renegotiate with existing shareholders for further injection of capital and/or conversion of existing loans to equity (b) included an improved cashflow statement in the Business Plan issued to financiers between July and November 2001 (c) arranged a larger overdraft facility (with personal guarantee if required) (d) retained the office premises equipment and some of the staff. The Claimant would or could thus have (e) presented a significantly stronger Balance Sheet to potential new investors and continued with (f) the development of its products (g) generating income and revenues from existing and new products (h) negotiating and completing contracts for the marketing and sale of its products”

There then follows a list of “commissioned work” i.e. work which it is suggested would have been commissioned by clients of BES, and “claimant’s own properties” i.e. BES’ own projects which it is alleged could have been continued and marketed. The statement of case then continues:-

“The Claimant had good alternatively reasonable prospects of progressing completing and or benefiting from between 50 to 60% of the above contracts which would have generated a total income in excess of £500,000 (or, thereabouts) over a period of eighteen months taking commercial advantage of the intellectual property rights and licence fees generated by products developed by the Claimant. The Claimant was deprived of the opportunity or chance of taking and completing these matters;”

The first sentence of sub paragraph (ii) is simply repetitive of (i). Thereafter the statement of case continues:-

“The Claimant would or could thus have avoided laying off staff, drastically cutting back on its business overheads and disposing of it's business premises and equipment on a forced sale basis. The losses under these heads amount to (a) £32,356 for payments in lieu of notice (b) £19,861 wasted recruitment fees (c) £18,535 net loss on disposal of premises and equipment (d) £2,000 costs of vacating and clearing premises (e) £18,000 wasted management time;”

There then follow in sub paragraphs (iii) to (vi) various small claims for consequential losses including a claim for £60,751 in respect of the cost of employing Mr Price to make the claims for R&D tax relief.

It is necessary to form a view as to what is most likely to have happened had S&W informed BES of the existence of R&D tax relief on the 30^th June 2001, being the latest time by which S&W should have provided that information, consistent with their duty, agreed by the experts. The only evidence directed to this issue was that of Mr Dickens, Mr Webb and Mr Joshi.

On the basis that it would have taken a month thereafter to prepare the claims in respect of the years to June 2000 and 2001 and allowing the four month period that it approximately took the Revenue to pay the claims that were actually submitted, BES would have received the gross sum of £113,495.11 at the end of November 2001. There would have been expenses incurred in the preparation of the claims but I accept that those expenses would not have been as much as those charged by Mr Price. I have no evidence or other guidance as to what costs would have been incurred by BES in preparing its claims in the likely circumstances then prevailing but, doing the best I can, I will put them at £20,000. As I have already found preparation of the claims ought to have involved a detailed inquiry into the work schedules of BES staff over the previous two years.

It follows that it is likely that at the end of November BES would have been approximately £93,000 better off in cash terms than it was. It would also have had the prospect of being able to claim for R&D tax relief in succeeding years. The extent of that claim would be dependent on how much qualifying R&D work BES performed in those years.

It must also be born in mind that R&D tax relief was not a simple payment to a qualifying company of a sum of money which it would not otherwise have received. The effect of the legislation was to entitle BES to receive immediately 150% of its qualifying R&D expenditure. However as a condition of the relief BES was required to surrender the amount actually so incurred and deduct it from any loss carried forward to future years against which future profits could be set off. Provided that BES ultimately achieved profits the effect, therefore, was to accelerate recovery of qualifying R&D expenditure and confer a further cash benefit of an amount representing half that expenditure. This is an important consideration when considering the effect that an entitlement to R&D tax relief might have on possible new investors.

It was not pleaded and no evidence was given as to which members of staff would have been laid off in the reduction of BES’ operating costs which would have occurred even had S&W told BES of the available tax relief in June 2001. It is accepted that the principle cause of BES’ leadership of the field in the production of interactive computer products was the presence on their permanent staff of Mr Evans with his acknowledged expertise and talents. I would assume that in order to retain its ability to complete or undertake projects BES would have had to have continued to employ its programmers and there would have had to have been some supporting management. The cost of premises would continue. I will assume for present purposes that it would have been possible to bring in staff on a ad hoc basis as required by particular projects.

The net saving to BES resulting from cutbacks of this kind would therefore only have been a saving of the costs of carrying staff during periods of inactivity when no projects were in hand. If this was what happened, and it is mostly conjecture on my part unsupported by any evidence, then there would have been continuing costs of running BES on this reduced basis which would need to be covered by revenue. It is hard to imagine that any programme of continuing qualifying R&D could be undertaken by BES in this state and, unless such a programme was continued, BES would not have been entitled to benefit from R&D tax relief.

I turn to consider what the prospects of such continuing revenue were. I have already described the collapse in profitability in the information technology sector in 2001 well illustrated by the performance of Flextech and Telewest BES’ principal customers. It is accepted that BES received virtually no new orders in the course of the year to June 2001 and that that pattern continued to the end of the year.

I now consider the lists of “commissioned work” and “claimant’s own properties” appended to sub-paragraph (i) of the particulars of claim set out above. As at December 2001 this list represents only prospects. BES had not at that time, obtained any contractual commitments for the production of any of these listed projects from clients and never did obtain such. There is virtually no evidence of any interest expressed by a client in respect of any of these listed items. At paragraph 13 of his witness statement Mr Evans says that he “completed the following interactive productions – Defectors; Scrabble; Haunted castle; Flashband and at least another 10 productions most of which in my view would have been completed and commercially exploited by the claimant had they continued active trading.”“Defectors” does not appear on the pleaded list.

As evidence of lost business prospects BES particularly relied on the “game engine” project which is referred to on the pleaded list as “Telewest – Game Juke Box Platform”. It was suggested that this project had the prospect of significant net revenue. BES drew attention to a letter of intent which it produced on the 9^th November 2001 identifying a potential contract value to BES of between £350,000 and £500,000. The project commencement date was originally the end of 2001, but it was postponed to April 2002 after Telewest had given what Miss Berry suggested was “verbal approval”. However no contract terms were ever agreed. A “letter of intent” intended to be signed by Telewest was never signed. Indeed there was no evidence that any specification for the project had ever been drawn up. It was therefore not possible to arrive at any reliable estimate of how profitable this project might have been if it had, in fact, come to fruition. Indeed Mr Evans’ evidence does not stoop to saying whether the projects derived from BES which he completed while at Flextech were profitable to Flextech. It is noticeable that no payment appears to have been made by Flextech to BES in respect of the intellectual property rights which BES must have had in the projects which Mr Evans appears to have taken with him to Flextech.

I am quite unconvinced that BES would have been able, in the prevailing market conditions at the end of 2001 and extending on to 2003, to have realised sufficient net revenue to cover the costs of maintaining itself even in the partially mothballed state which has been suggested.

It seems to me to follow from this conclusion, and notwithstanding the evidence of Mr Joshi and Mr Webb, that there was no real prospect in December 2001 for the raising of fresh capital, either from its existing shareholders or from outside investors, to carry BES forward until the market for its products recovered. The fact is that the general market for information technology products had not recovered even by 2004.

I have already pointed to the accepted view that BES’ position in the market depended on the services of Mr Evans. By the end of 2001 his relationship with Miss Berry, which seems to have been the basis for launching BES originally, was over. The cause of that break up was not explored in the evidence and it does not follow that it would not have happened had BES continued in semi mothballed form. I doubt whether BES was an investment prospect in the absence of Mr Evans. Be that as it may, BES’ attempts to raise further capital in late 2001, but at a time when it still had its full staff, failed.

The present position of BES is that it is insolvent in the sense that its in-house loan creditors have not been paid and there is no prospect of them being paid. But it has no outside creditors who might wish to enforce payment of their debts. Theoretically therefore it could still be revived if it had assets, such as intellectual property rights capable of exploitation, which would make it worthwhile to revive. It is, however, apparent that such is not the case.

In my judgment even if S&W had informed BES of the possibility of obtaining tax relief in June 2001 and BES had been able to recover that relief at the levels and in respect of the types of expenditure which it appears to have succeeded in doing pursuant to the claims it later made, and even if in consequence BES had not laid off its staff and disposed of its premises and equipment in December 2001 but had continued in its suggested “semi mothballed state”, it would not have survived, but would have been compelled later to carry out the further cost reductions which it in fact did at the end of December 2001 so that its present position would be no different than it actually is today.

For these reasons it seems to me that the claim must be dismissed.