HMRC FTT win has implications for R&D claimants

HMRC FTT win has implications for R&D claimants

A recent First-tier Tribunal judgment has been published with important R&D tax implications.

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David Woodward

Partner

KPMG LLP (UK)

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A First-tier Tribunal (FTT) judgment on the subject of an R&D claim, Hadee Engineering Co Ltd v Revenue & Customs, has recently been published that has important implications for all Research and Development (R&D) tax relief claimants but particularly companies that claim under the Small and Medium Enterprise (SME) regime.

In the judgment, the FTT agreed with HMRC in rejecting six out of seven projects that formed the basis of the company’s R&D tax claims, the seventh project was partially accepted. The key points were that the burden of proof in demonstrating activities meet the definition of a R&D project are with the taxpayer. It is not sufficient for the company to argue that they are the experts in their field of technology and HMRC should accept their assertions.

The FTT agreed that it was appropriate for HMRC to seek evidential proof to support the assertions of the ‘Competent Professional’ (taxpayer) and, therefore, retaining and cataloguing documentary evidence to support the claim is of critical importance. The FTT also focused on the qualification of the Competent Professional (the concept of the Competent Professional is central to R&D, it is the person with the right qualification, knowledge and experience in their field of science or technology who assesses what is eligible as R&D) chosen to assess the R&D Projects, they need to be experts not generalists.

HMRC also challenged whether the company met the conditions for the SME regime. Two of the three conditions challenged still remain relevant under the current rules and it is important that SMEs that perform R&D for customers consider whether the following two conditions have been met:

  • First, to claim under the SME scheme the R&D expenditure must not have been subsidised directly or indirectly by any other person. This condition is not limited to grant funded innovation projects and has been more widely interpreted by HMRC to potentially include circumstances where R&D is performed in commercial situations e.g. the sale of a bespoke product; and
  • Second, the R&D must not relate to activities contracted out by another party. It is clear from HMRC’s arguments that they consider that many contractual arrangements may be caught by this condition and this may exclude companies making SME claims where the R&D is to fulfill contractual obligations.

SME companies that do not meet the above conditions may be eligible for the R&D Expenditure Credit that provides a cash benefit of circa 10.5 percent of qualifying expenditure as opposed to circa 25 percent.

The case has important lessons for all R&D tax claimants but especially SME companies claiming under the SME regime where the R&D is related to fulfilling specific customer requirements. This could include the sale of bespoke products or provision of bespoke services requiring R&D.

The case highlights the importance for companies making R&D claims to carefully consider conditions for the SME regime. It also highlights the importance of documenting the qualification criteria for R&D and the importance of making and retaining robust primary documentation supporting the basis adopted for the claim.

R&D incentives provide a very generous and important incentive for companies innovating in the UK. Our advice is that companies ensure they document both the qualification and quantification of their R&D claims and seek professional advice where required to ensure the claims are compliant. KPMG’s Innovation Reliefs and Incentives team helps companies with their R&D claims and advises on issues companies are facing.

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