Our senior R&D team have been reviewing HMRC’s change in approach to scrutinising R&D claims and recommend that every claim and supporting information is more robust now then ever, with a review by an R&D specialist being a sensible precaution.
Over the last year, HMRC have taken on more than 100 new compliance staff to their R&D section, why?
In the past, the R&D schemes have helped to encourage innovation in numerous companies and the very generous tax relief associated with the schemes has totalled nearly £40 billion since they began, so it is not surprising that HMRC are keen to ensure they are still being used as originally intended.
Whilst we are aware that HMRC are undergoing a review of the current R&D schemes to ensure they are still meeting the objectives that they set out to achieve, the recruitment surge also raises the concern that we are going to see an increase in enquiries to genuine R&D claims.
It is, therefore, more important now then ever to make sure any claims are as robust as possible.
There are currently two R&D schemes in existence, with the SME scheme being worth approximately three times the RDEC scheme:
- SME (Small and medium size enterprise) R&D tax credit scheme- Under this scheme companies can deduct an additional 130% of their qualifying costs, giving total relief on qualifying expenditure of 230%. If this deduction results in a corporation tax loss the Company can surrender the loss for a 14.5% tax credit.
- RDEC (Research and Development Expenditure Credit)- under this scheme large companies can claim a tax credit of 13% on qualifying expenditure.
So, what do we think HMRC will be looking at in particular?
It was hoped that HMRC’s increased activity in the R&D unit would be focused on the more exaggerated and unjustified claims however we have seen some unwanted movement in relation to client-led R&D which may impact your company.
There are different types of client-led R&D which can normally be placed into the following categories:
- Subcontracted- the contractor company owns the R&D and the knowledge created by it;
- Subsidised- someone is funding the costs of carrying out the R&D; or
- Commercial- the company carries out R&D to be able to fulfil a customer order.
If you undertake client-led R&D, either subcontracted or subsidised then there is no argument, you fall within the less generous RDEC scheme. The “grey area” which is currently being brought into question is “commercial R&D”.
For example, your company has been approached to provide a piece of machinery for a client, this machinery needs to carry out a particular function. When you investigate this further you find that the functionality and capability that the customer has requested does not readily exist. As a result, you must undertake R&D first to enhance your knowledge before fulfilling the customer’s order.
Up until now, HMRC have accepted that the above position does not represent subcontracted R&D as the client approached your company for a piece of machinery not to undertake R&D. This argument is normally strengthened by the fact your company would be taking significant risk as the R&D involves technical uncertainties which could erode any commercial profit. These uncertainties make it hard to predict the amount of time involved and additional time required for R&D.
In contrast, if the company specifically charges the client for the time spent on R&D this is without a doubt subsidised R&D and would fall within the RDEC scheme.
As noted above, HMRC appear to be changing their approach and are actively looking to reclassify expenditure, such as that described above as “subsidised” or “subcontracted”. HMRC’s revised argument appears to be that the client is paying for a service, including any company investment in R&D, and therefore it should be treated as fully subsidised.
HMRC are disregarding specific contractual arrangements or commercial profit margins. They are also overlooking the fact that any commercial contract is separate to the company’s investment in R&D.
This shift in approach could invalidate a high level of current SME claims, with only R&D carried out to develop a new product or service (before any customers are identified) qualifying for the more generous SME scheme.
The Chartered Institute of Taxation are taking an active role in collaborating with HMRC to help steer any changes, as HMRC’s change in approach seems to move away from the policies intentions.
Whilst this is just speculation at this stage, we would suggest you are comfortable with what and how your company is claiming R&D tax relief and be aware that there is a potential risk of increased HMRC scrutiny into R&D claims. If you have any concerns surrounding your claim, please do not hesitate to contact email@example.com and we can actively review your claim to ensure it is as robust as possible.