What does that mean now for R&D claims where R&D was required to fulfil a contract?

Let’s kick things off with some background!

Sub/Sub is HMRC taking a two-pronged attack on an R&D claim against a company claiming for R&D that has arisen as a direct result of trying to deliver a project which requires R&D to complete it and is subject to a contract. The two “Subs” are:

Subsidised – a subsidy is often a grant, whether that be from a quasi-government organization like Innovate UK, a council or a foundation. However, sometimes it is also just be a sum of money that is awarded/gifted to a specific organization sometimes to support the R&D and sometimes just to support the overall operation of the business, in both cases, if it subsidises the cost of all or part of the R&D costs that a company has incurred, then the company should claim those subsidised costs as a Research and Development Expenditure Credit (RDEC) and not claim for enhanced expenditure under the SME scheme.

Subcontracted – subcontracted’s generally interpretation is one company asking another company to do a very specific thing. Consider clinical research, big Pharma and Biotechnology companies “subcontracted” their Clinical Trials to specialist Clinical Research Organisations, as they had the scale and the knowledge that was lacking in Pharmaceutical companies whose main aim was to develop compounds and then market those compounds that were proven to be successful and safe in clinical trials. Normally it would be performed on a time and materials basis and the subcontractor would be paid for their efforts regardless of success. R&D subcontracted by a Large Company to an SME should be claimed using RDEC, not the SME Scheme and if a company was genuinely subcontracted to by an SME, then the SME would claim rather than the contractor.

The start of this sorry story

Approximately 3 years ago HMRC quietly changed their guidance at CIRD84250, no-one outside of HMRC knows when, only that when The Wayback Machine checked the page on 20^th April 2021 it had the old description and when it next visited the page on 30^th November it had changed.

The key changes were the addition of this sentence:

“Any activities carried out in order to fulfil the terms of a contract are considered to have been contracted to the company.”

And the removal of this one:

“As part of any examination it may be useful to examine the degree of autonomy enjoyed by the person engaged, the ownership of intellectual property, and the economic risk in any arrangements.”

They also amended the guidance on subsidised R&D at CIRD81650 adding a significant chunk of new text starting with this paragraph

“The legislation separately provides that expenditure is also subsidised to the extent that it has been met, directly or indirectly by any other person. So expenditure may be “subsidised expenditure” even though the payments are not, for example, a grant or subsidy paid by a public body.”

Further into the additional verbiage under the statement “What is considered to be a “clear and direct link” will depend on the facts in each case.” Is this kicker

“ • Payment received for undertaking a contract will be considered to meet expenditure incurred in undertaking that contract.”

And in an instant the world of R&D Tax Relief for SME claims was turned on its head! These updates were made on the QT, they were not referenced in the change logs, whether HMRC thought that the R&D Advisor Community had simply forgotten what was in the original narratives and would suffer from collective amnaesia who knows. The Stage One Creative Tribunal hearing notes confirm that this change did actually take place on 30^th November 2021.

In another twist all of the tribunal cases that I reference below all had enquiries that were opened to test HMRC’s revised interpretations before they updated their own guidelines for those revised interpretations. Talk about putting the Cart before the Horse.

Reasoning for the change

To be fair to HMRC their logic was sound, to prevent both parties to a contract from claiming for R&D Tax Relief on the same costs. I don’t know whether there is actually any evidence of some R&D advisors working with both parties to a contract and submitting the same claim for both the contractor and the subcontractor, but we got the feeling that this was implied at one of the subsequent meetings of the R&D Consultative Forum that this had been the case. And indeed I believe this is specifically referenced in one of the rulings below.

Given what we have learnt about some advisors’ ethics and behaviour in the last 4 or 5 years that has come out over the last 6 to 9 months, it wouldn’t be a surprise for most of us in the R&D Advisory Community for this to have actually happened.

Our Knee Jerk Reaction – Mirrored by a majority of advisors

In a case of Turkey’s voting for Christmas (or perhaps Thanksgiving to keep up with the Americanisms and the timing of this article), to the detriment of some of our clients and our own income, we decided to toe the line and follow the revised guidance for fear of receiving one of those dreaded brown envelopes containing a “Notice of Enquiry” letter from HMRC. Hastening to add here that we took these decisions in collaboration with our clients and explained our reasons why we thought it was mutually beneficial and they have agreed with us almost in their entirety.

Our client base is one where the value of claims is not stratospheric and whilst only getting back 10.53% of eligible spend instead of 24.7% or 33.35% was disappointing it was often a matter of maybe £30,000 at most in the value of a claim.

Let Battle Commence

Fortunately, there have been some advisors and some companies who have been braver and have taken on HMRC and their revised interpretation of Subcontracted R&D, to be fair they had a lot more to lose.  To date the three companies that have taken on HMRC have been in “construction” related industries and each have had more than a million pounds at stake in their SME scheme claim. So taking HMRC to the First Tier Tax Tribunal (FTT) had significant financial upsides.

 

Quinn (London) won the first skirmish

First under the microscope was Quinn (London). HMRC only sought to disqualify their SME claim because their costs had been indirectly subsidised by the other parties to the contracts on the refurbishment of various listed buildings. HMRC argued that even though it was after the fact, the customer paying the invoices for work completed was in essence subsidising, albeit indirectly, the R&D that was being performed. Forrest Brown were the R&D advisors defending the claim and supported at Tribunal by Laurent Sykes QC of Stewarts Law.

HMRC lost, Judge Harriet Morgan in her ruling stated ““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, 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 it 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.”

In a bizarre twist after the ruling, in a subsequent R&D Consultative Forum Meeting HMRC “discussed” the case and sensationally stated that in their opinion the tribunal had erred in their ruling and further argued, had they brought the case under their revised guidance for subcontracted R&D, they would have won the day! Despite this strength of feeling HMRC didn’t nail their position to the mast and refused to appeal the decision to the Upper Tax Tribunal (UTT) and create case law.

• to the home team!

Ironically despite HMRC’s defeat of their revised interpretation of subsidised R&D, the changes to the CIRD Guidelines, that I reference above were only implemented after this defeat in, what some might say, a case of HMRC thumbing their nose at Judge Morgan.

Collins Construction wins the first battle

As HMRC marshalled their troops and brought their revised interpretations to the front line, their sights fell on Collins Construction. Similarly in the construction space, this was the first claim going to FTT that faced the pincer approach of a rejection of the claim as both subsidised and/or subcontracted R&D. We’ll comment on this approach in our summing up.

Collins Construction was actually the second of two lead cases to be heard, there are a number of other cases with similar situations to Collins, stayed behind this ruling, and still more behind the other ruling. The Judgement was handed down on 21^st October 2024 and HMRC had 56 days to appeal the decision.

As the title of this piece suggests they lost on both fronts in para 73 of the ruling the Tribunal Judge Kim Sukul on the subcontracted argument stated “Objectively assessing the meaning which a reasonable legislature would be seeking to convey in using the words “contracted out” and “contracted out R&D”, we do not consider the broad interpretation suggested by HMRC to be appropriate. We consider the natural meaning of the words used in the provisions excludes the relief in circumstances where the qualifying expenditure is on research and development activities, when those activities are carried out on behalf of another person.” Judge Sukul, also took the findings from the Quinn (London) FTT case mentioned above and despite HMRC arguing that the Tribunal in Quinn was wrong or had erred in their judgement, this tribunal agreed with the Quinn tribunal in stating that a “clear link” was necessary between the price paid and the cost of the R&D and in both cases that had not been established.

This case was initially argued by Adam Spriggs and Fiscale on the R&D side and by Edward Hellier at Tribunal

3-0 to the home team, 2 defeats on subsidised and a first on subcontracted.

Has Stage One Creative won the war?

This ruling was published online on 28^th November 2024 and like in Collins, HMRC has lost on both counts of Subsidised and Subcontracted in another First Tier Tribunal defeat. Mark Doodney, Croner-i and Clive Owen LLP argued the case up to tribunal and were supported by Charles Bradely of Pump Tax at tribunal.

The decision broadly aligns with Collins Construction but Stage One Creative are not quite so focused on construction, in the way that both Collins and Quinn (London), they are however involved in the exhibition industry.

There was one major difference between Stage One and Collins, which perhaps may have been an attempt to go down in a blaze of glory, HMRC took the step of opening discovery assessments into previous claims submitted by Stage One Creative Limited and retrospectively apply their revised guidance on subcontracted R&D on claims submitted before the guidance was even updated. This was also dismissed.

5-0 to the home team, 3 defeats on subsidised and now 2 on subcontracted.

Our reasoning and response

Stage One haven’t necessarily won the war, but it’s reasonable to assume that they may have breached the dam and we expect there will now be a flood of claims from companies who either withheld submissions or companies who may have followed the revised guidance and feel the time is now right to amend their claim to an SME scheme claim.

It would appear that HMRC have twisted themselves in knots in trying to create and enforce these peculiar interpretations of the tax law. It would seem incoherent to argue that it is subsidised and if it isn’t subsidised, it must be subcontracted, surely their argument would be stronger if they argued it was one or the other. Particularly because in both the original and the revised version CIRD84250 HMRC themselves state “Where a company carries out R&D on its own account and simply receives a subsidy from another entity, this is not subcontracting – it is subsidised expenditure.” So, they should know the difference!

The conspiracy theorists in the office wonder whether HMRC have been acting as proxies for HM Treasury and have created these interpretations to discredit the SME scheme, and as this has now been removed from the tax legislation for accounting periods beginning on or after 1 April 2024, that they have already won the war and that these FTT rulings are simply hotspots within the dying embers of battle.

The SME scheme realistically met its maker after a mandatory random enquiry programme (MREP) in 2022, which followed hot on the heels of the changes to the CIRD guidelines identified significantly increased levels of error and fraud of £1.13bn in 2020-2021. The fact that HMRC have so far hidden behind arguments of the cost and the time to collate as reasons not to fully respond to Freedom of Information Requests into the specific causes of error in their MREP that led to these high levels of error, has added fuel to the conspiracy theory fire.

What next?

HMRC initially suggested that if they lost at FTT, they would proceed to the UTT, the first FTT ruled on 21^st October 2024, so HMRC had 56 days to appeal to the UTT, that means they have until 16^th December 2024 to make an appeal. If they don’t appeal, will that further fuel the conspiracy theorists?

We’ll be writing to a number of clients who haven’t submitted a claim, to discuss whether they want to begin working on claim periods that are still open, and which have similar characteristics with these three cases and suggesting that the time may be right to submit an SME scheme claim.

For those companies that either submitted an RDEC claim or didn’t submit a claim for accounting periods that are now closed there’s nothing that can be done, yet!

Historically when HMRC have policed elements of the R&D Schemes incorrectly, it happened with the reimbursement of out of pocket expenses, they have allowed companies to amend their claims that were out of time during an amnesty window. However, with no UTT ruling, it’s uncertain whether this will happen.

In another twist, the new merged scheme, which applies to accounting periods starting after 1 April 2024, has rules on R&D that has been contracted, which are very similar in effect if not in wording to the original guidance that HMRC changed in 2021. Make of that what you will.

In summary

There is a growing body of evidence that HMRC’s position on subcontracted and subsidised R&D is untenable, three devastating rulings, even if only at FTT, two of which had a large number of cases following behind them, both of which supported the original ruling on subsidised R&D in Quinn, represents a strong body of evidence.

HMRC’s decision on whether to appeal or not will be telling!

As for the conspiracy theories who knows anything is possible!

We’ll keep supporting our clients old and new and will discuss with them the risks and merits of an R&D Claim. Nothing in life is risk free and the same applies to the best presented R&D Claim in the world.

If you have a query about any R&D claim, why not reach out for a chat, you can book a meeting at a time convenient to you and we can start a conversation. If you are an accountant that doesn’t want to take the risk of supporting your clients anymore, we’d be happy to talk with you about how we can help manage the risk with you or for you.

It all starts with a conversation!

Artwork produced by Shanel Richardson,  https://linkedin.com/in/shanelrichardson , https://shandwich-artist.carrd.co