by Jesminara Rahman
In recent years, the tax terrain for Research & Development (R&D) has experienced significant changes, introducing what appears as barriers put forward by HMRC. These barriers signify a substantial shift in HMRC's approach from processing R&D tax credits first and checking later to an immediate stance of review and rejection.
These transformations have introduced three primary challenges for companies pursuing R&D tax claims, particularly when subject to tax investigations. The most prominent hurdles emerge at the second and third stages of the claim process.
The initial obstacle in the journey of an R&D tax claim is convincing HMRC that the work qualifies as research and development. This presents a unique conundrum, as HMRC, in its role as laypeople, often disputes the expert opinions provided by competent professionals. HMRC's lack of expertise in specific technical domains makes it challenging for claimants or their agents to strike the right balance in the level of technical detail presented in their narratives.
Striking this balance is crucial because overly simplified explanations may not convey the true nature of R&D, while overly technical descriptions can confuse HMRC. In some instances, the advancements in technology or science are challenging to prove, especially if they are documented after the fact by a third party. In such cases, HMRC's scepticism may be reasonable.
Nevertheless, there are scenarios where the claimant has garnered awards for their work or where independent experts have confirmed the R&D nature of a project. Surprisingly, HMRC has still initially rejected these claims, asserting that they do not meet the criteria for R&D. This pattern of seemingly arbitrary refusal is a source of concern for many tax agents and claimants.
Subsidised expenditure, defined under s1138 of CTA 2009, incorporates various elements, including expenditures covered by state aid notifications or other non-state aid grants and subsidies.
It is primarily s1138(1)(c) that leads to disputes between claimants and HMRC. This section relates to scenarios where a customer pays the claimant for R&D work, which HMRC considers as subsidised expenditure due to a perceived connection between the payment and R&D costs.
In the Quinn (London) Ltd v HMRC case in 2021, the Tribunal ruled that a "clear link" was absent between the client's payment and the R&D expenditure, thus concluding that the expenses were not subsidised. The judge argued that it would be inconsistent with the SME scheme's intent to restrict enhanced R&D relief solely because the claimant aimed to recover R&D costs under commercial contracts with clients.
While HMRC disagrees with this ruling, HMRC has not pursued an appeal at Upper Tax Tribunal. Despite the Quinn case's outcome, HMRC's stance, as outlined in guidance at CIRD81650, remains unchanged.
HMRC often denies R&D claims when a customer and a contract exist under S1052 and S1053 Corporation Act 2009. Specifically, this issue relates to the condition set out in s1052 (in-house expenditure on direct R&D) and s1053 (subcontracted R&D), which outlines that R&D expenditure should not be incurred while carrying out activities contracted out to the company.
HMRC's guidance makes it clear that any activities carried out by a taxpayer to fulfill a contract are considered as contracted R&D. This includes situations where one company pays another for the provision of workers or materials. The Hadee Engineering Co Limited case in 2020 offered further insights into how HMRC views R&D carried out under a contract, emphasizing factors such as intellectual property ownership, financial risks and rewards, autonomy, and deliverables/milestones.
The R&D tax landscape is currently in a state of flux, with HMRC selectively following First Tier Tribunal (FTT) decisions, often adhering to their interpretations, such as the Hadlee Engineering case. The upcoming tribunals this winter in 2023 may provide further clarity.
These developments are a testament to the evolving and complex nature of the tax landscape, which demands careful navigation by all involved parties.
Jesminara Rahman is the Director of Tax Resolute with over 23 years of experience in tax investigations. Sign up to our newsletter to stay up-to-date with with all our Tax publishing and content for professionals in the field. Follow the link at the bottom of this page.
