A recent tax case at the First Tier Tribunal has highlighted several key lessons about managing R&D claims and helped to clarify how HMRC interprets some of the key qualifying rules for claiming R&D relief under the SME scheme. Businesses who learn these lessons are much more likely to succeed with their claims for R&D tax credits.
The arguments
The case concerned a number of projects carried out by an engineering company in delivering specialised and bespoke products to its customers. The disputed claims related to projects carried out ten years ago and finally came to court after HMRC issued a closure notice on an ongoing enquiry as the company (in its view) had failed to provide sufficient evidence to resolve the enquiry.
As well as providing confused details of costs of the works carried out, crucially, the director representing the company was unable to provide conclusive evidence that it had carried out R&D work, and that this was done in its own right. For some of the projects, HMRC had argued that the work to create bespoke products for their customers had involved no research and development to resolve a technical uncertainty through an advance in technology. HMRC also maintained, that for some of the projects, even if there was qualifying R&D, the company was merely providing an outsourcing service for its customer as it had been engaged to design and manufacture a bespoke product (so any R&D relief would accrue to the customer).
Another important line of attack from HMRC was that even if there was genuine R&D work carried out by the company in its own right (rather than as a subcontractor) the claims failed because the work was ‘subsidised’ by their customers. It argued that the fact that the company received payment for a ‘bespoke’ product involving R&D amounted to a subsidy for any R&D expenditure, ie the uncertainty over the project was factored into the price. This would mean that no claim for R&D under the SME scheme would be possible (although a claim under the RDEC scheme may have been possible if the other conditions had been met).
The Tribunal dismissed the taxpayer’s claims for all but one of the projects considered.
Lesson 1 – keep good records
The clearest learning point is that all R&D claims should be supported with a clear audit trail of evidence. The most important evidence will relate to the technical issue that the R&D work was carried out to resolve: can you demonstrate what the technological uncertainty was and why R&D work was needed to resolve it? Selling a bespoke product does not automatically mean that qualify R&D has taken place. Then a claim must also include specific records relating to the costs of that work (ie those costs relating solely to the project).
Lesson 2 – get the contracts right for non-standard products
For all contracts that are not a sale of an off-the-shelf product, the contract should include a clear delineation of any project responsibilities and costs to adapt or enhance the product for the customer. Where it is clear that the customer is bearing all the costs (and risks) of such work, it is highly unlikely that the supplier will also be able to make an R&D claim.
However, where it is not possible to pass on such costs to the customer and there is a chance that a technical uncertainty needs to be resolved to deliver the project, the contract should make clear that the supplier is taking on the financial risk of unknown costs. It should also make clear who owns any intellectual property/design right that arises from the project: where the supplier retains the IP, this helps to demonstrate that it has undertaken R&D work in its own right.
Lesson 3 – have your R&D claims pre-checked by experts
HMRC will always consider R&D claims rigorously so providing clear evidence to support how each of the qualify conditions is met and how costs have been arrived at is vital. BDO’s team includes engineers and technical experts who can work with your technical team to analyse and understand your research and help you present it to HMRC in clear and concise way. We also have huge experience in helping businesses identify all their qualify costs so that they can be claimed.
For help and advice on any R&D claim please get in touch with your usual BDO contact or Cathy Kelly.