February 2021 Update


‘UK R & D tax relief cannot be granted unless there is clear evidence of a scientific or technological ‘advance’ in capability or competence. Sometimes this can be the full scale invention of a new product, process or system; sometimes it may be the slightest gradation of an improvement. Whatever the degree, the advance must be noticeable and evidence based.
HMRC’s approach is shown in the recent first tier tax tribunal case, writes Maria Kitt, in an enquiry dating back to 2012, HMRC rejected an engineering company’s claim to SME relief. What followed shows the depth of evidence required by a company to claim relief. This is a ‘helpful’ case, if disappointing for the company concerned. Further details can be read here…..

A First-tier Tribunal (FTT) judgement 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 judgement, 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.