HMRC’s highly anticipated update regarding the long-standing topic of subsidised/subcontracted expenditure was released yesterday. This follows last year’s first-tier tribunal cases involving Collins Construction and Stage One, where both companies successfully defended their position that the R&D activity was neither subsidised nor subcontracted, making the associated relevant expenditure eligible to be claimed under the SME scheme. HRMC rightly refused to give an explicit update on what its position was directly following the tribunals, and resultingly the R&D tax industry has been on tenterhooks, anticipating yesterday’s announcement for months.
This uncertainty dates back to before the Quinn (London) Ltd vs HMRC (2021) case whereby HMRC began to refuse R&D claims under the SME scheme if a company had received a payment for services rendered, in cases where the client had limited or no knowledge of the requirement for R&D to be undertaken as part of the project. At RCK we’ve always remained resolute that if a company undertook the technical risk, and the contract did not explicitly assign R&D ownership to the customer, then there was a strong case that the R&D was not subcontracted. Following the Quinn case, HMRC updated its guidance stating that any work carried out under a contract, regardless of whether R&D was known to be required, would be classified as subcontracted/subsidised. As a result, such claims would either fall under RDEC or be disallowed entirely, depending on the circumstances.
It's clear that differing tribunal outcomes, HMRC guidance updates, and the definitions regarding subcontracting under the merged scheme, led to confusion. As such, the recent updates are a welcome relief for all of us looking for closure on the matter.
Two updates were released by HMRC, one covering subcontracted activities (CIRD84250) and one covering subsidised expenditure (CIRD 81650), summarised below:
Subcontracted Expenditure (CIRD 84250)
- If the R&D is incidental to the supply of a product or service, it is not contracted out
- If the company has a limited degree of autonomy, R&D is more likely to have been contracted out
- If the company has limited financial risk in undertaking the work, it’s NOT a strong indicator that work was not contracted to the company. The absence of financial risk is a stronger argument the work has been subcontracted (i.e. if a customer is picking up all the bills no matter the overspend due to R&D, they would by virtue, know that R&D is taking place and be willing to subsidise it)
- If the claimant company does not retain IP arising from the R&D project but the customer retains the IP, then the work would likely be deemed contracted or indeed the R&D would be wholly owned by the customer and the claimant company would be ineligible.
In summary, if the R&D is undertaken to meet the requirements of a contract (i.e., if it is not incidental) and the customer is aware of it, there is a strong likelihood it will be classified as subcontracted. If intellectual property (IP) ownership is a factor, it can further clarify who is eligible to claim. In all cases, the relationship between contractor and principal would need to be established, and contracts assessed, to make a definitive judgement on whether the work is to be classified as subcontracted.
Subsidised Expenditure (CIRD 81650)
The guidance update with regards to subsidised expenditure is clearer than for the subcontracted expenditure. To summarise:
- The rules around notified state aid are consistent in that any expenditure subsidised by notified state aid within a project result in the entire project expenditure being eligible for consideration only under the RDEC scheme.
- Where a company receives payment under the contract, but R&D activities are deemed to NOT be subcontracted then the R&D expenditure is not subsidised.
- The receipts from sales for goods or services either developed as part of the R&D or existing prior to the undertaking of R&D are not to be considered as meeting expenditure incurred on R&D, as long as the company carries out R&D on its own account.
- HMRC considers where a clear link exists between the funds/payments provided and the incurred expenditure then it would be considered to be subsidised.
While these updates offer some clarity on previous questions regarding this section of the CIRD guidance, it’s important to note that the provided examples and conditions are not exhaustive. Although HMRC has made a clear effort to define boundaries in what has long been a contentious area, the classification of expenditure as being subcontracted/subsidised, or not, will ultimately depend on the specifics of each individual case.
The guidance is now significantly clearer, and the majority of cases we’ve encountered (and rigorously defended as not being subcontracted),where a company conducts R&D under contract, but the R&D is not the contract’s primary focus, would not be scrutinised as potentially being subcontracted.
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