R & D – HMRC clarifies subcontracted activities

R & D – HMRC clarifies subcontracted activities

There has always been some confusion between customers and subcontractors in the R&D schemes. In fact, clarifying this was a major aim of the new Merged and ERIS schemes, which were introduced for accounting periods starting on or after 1 April 2024.

However, many claims are still submitted using the old SME scheme, and HMRC’s window for compliance checks means that the SME scheme will be relevant for some time.

However, recent challenged and a number of decisions going in the claimant company’s favour has prompted HMRC to revisit their position on subcontracted R&D in the SME scheme, with updated guidance published recently that changes these subcontracting rules.

The most important thing to remember is that this new guidance only applies to the SME scheme and its sister, the R&D Intensive SME scheme. There are now five different R&D schemes to keep tabs on, so it’s easy to lose track. The other schemes have their own restrictions and rules regarding subcontracting.

In late February, HMRC updated its guidance concerning the definition of ‘subcontracted activities’ within the SME R&D tax relief scheme.

The new guidance means that HMRC have abandoned its blanket rule, with the revised guidance stating that the facts should be considered on a case-by-case basis and consider a number of factors. That means there’s no clear-cut rule on which party can submit a claim.

The continued purpose of the guidance is to prevent ‘double dipping’. HMRC wants to avoid situations where both the company commissioning R&D and the company undertaking it claim relief on the same expenditure.

Crucially, HMRC has stressed that the terms of the contract alone are not decisive. Instead, a comprehensive assessment is required, considering factors such as the nature of the R&D, the degree of autonomy exercised by the subcontractor, the allocation of financial risk, and the ownership of intellectual property (IP).

Key considerations for businesses

• Incidental versus required R&D: In deciding which party should claim, it’s important to carefully distinguish between R&D that is incidental to the supply of a product or service and R&D that is specifically required by the customer. If the customer expressly demands or is aware that R&D is essential for the project, it is more likely that the claim will be deemed to sit with the customer.
• Autonomy and control: How much control the customer has over the R&D process is a vital factor. If the subcontractor has limited autonomy, and the customer gives detailed specifications and is actively involved in the R&D, this again indicates that the claim is most likely to sit with the customer.
• Financial risk: The allocation of financial risk is another key point. If the subcontractor bears minimal financial risk, particularly if payment is assured regardless of the R&D outcome, it strengthens the argument that the R&D was contracted and the claim would sit with the customer.
• Intellectual property (IP): While the retention of IP by the subcontractor can be a factor, HMRC places greater weight on formal IP ownership rather than on informal ‘know-how’.
• Documentation: Project documentation, such as contracts, correspondence, and records of discussions, can be vital in assessing which party should be making the R&D claim. In the event of an enquiry, this documentation will be essential to back up assertions that the claimant was the true owner of the R&D activities.

SMEs should be particularly mindful of these changes, as they can significantly impact which companies can claim for R&D tax relief through the SME and R&D Intensive schemes. It is also important to remember that if HMRC opens a compliance check into a claim by a customer, they may request to speak to the subcontractor. If that is refused, they may use third party notices to get the information they need.

Conclusion

The updated guidance on subcontracted R&D activities for the SME scheme is a significant shift in the R&D tax relief landscape. By understanding these changes and conducting thorough assessments of R&D projects, claimants can ensure they submit compliant claims.