R&D tax relief is not available under the small and medium enterprises (SMEs) scheme for the cost of R&D work which is subsidised. But just because a customer pays a company for a finished product or solution, which is enough to cover the claimed spend, does not mean that the R&D work is subsidised. R&D is only subsidised where there is a clear link between the price that the customer pays and the cost of the R&D work.
R&D tax relief recap
R&D tax relief is a generous tax break for companies seeking a scientific or technological goal which involves significant challenge (i.e., the work is not minor or routine). The SME scheme gives an extra Corporation Tax write-off which is 130% of the qualifying spend, falling to 86% for expenditure incurred on or after 1 April 2023. So, for profitable companies the relief is worth 25p for every £1 of eligible spend changing to 22p, or loss-making SMEs can take a cash payment from HMRC, called a “tax credit”, of 33p in the £1, reducing to 19p.
Facts of the case
Quinn was a building contractor that claimed enhanced R&D relief for a number of its construction and refurbishment projects where it generated new technological knowledge or capability which it would be able to use in future projects. To claim R&D tax relief, a number of conditions must be met. One is that the cost cannot be “subsidised”. This includes the cost being “met directly or indirectly” by someone else.
HMRC refused Quinn’s claim, arguing that the works had been subsidised because Quinn was paid by its clients for the finished building works and those payments were enough to cover the claimed expenditure.
Decision of the tax tribunal
The tax tribunal judge was unimpressed by HMRC’s arguments and concluded that work was only “subsidised” when there was a “clear link” between the price paid by the customer and the R&D spend. Instead, under Quinn’s circumstances, the contract with its clients was to provide specified construction works in return for an agreed price. Tribunal Judge Morgan commented:
“… it would be wholly out of kilter with the overall SME scheme, if an SME were to be denied enhanced R&D relief solely because, in doing what is envisaged by the legislation (namely, utilising the relevant R&D for the purposes of its trade), as is usual and to be expected of an entity carrying out a trade on a commercial basis, it seeks to recover some or all of the relevant costs of the R&D under its commercial contracts with its clients entered into in the course of its ordinary trading activities. Indeed, if HMRC’s approach were to be adopted, the circumstances in which an SME could claim enhanced R&D relief would seem to be confined to those where it has no prospect of exploiting the R&D for commercial gain.”
Key takeaway point from the Quinn case
This is a common issue affecting many companies across a wide range of industry sectors, so the tax tribunal’s decision is welcome. Unfortunately though, tribunal decision are just persuasive (not legally binding). HMRC are sticking to their guns that they have a different view of the law, yet have chosen not to appeal the decision, and even recently updated their published guidance to reflect their stance that the tribunal rejected. This leaves claimant companies and their advisers in continuing limbo. So, we expect to see further HMRC challenges into costs incurred by claimants on commercial contracts for customers. This makes it more important than ever to seek advice in advance to make sure that contract and payment terms help support R&D tax relief claims. This is help that Gateley Capitus’ R&D tax specialists and Gateley Legal’s commercial lawyers can together provide.