Whether you are new to R&D tax credits or have been claiming regularly, the R&D Tax Relief programme is not always straightforward to figure out and the rules can be confusing to taxpayers. We frequently receive questions from companies, both those new to the program and those who have claimed in the past, about how to interpret the regulations and policies governing R&D tax credits in the UK. First and foremost, to determine and maximise expenditures in these complicated areas requires a clear understanding of the BIS (Business, Innovation & Skills Guidelines on the ‘Meaning of Research and Development for Tax Purposes’) and various CIRD (Corporate Intangibles Research and Development Manual) guidelines, as well as what HMRC considers being a reasonable submission. Companies submitting R&D claims may be grossly under-claiming or unknowingly triggering a query from HMRC.
R&D and Tax Credit Relief
If you do any sort of reading up about the R&D tax credit regime in the UK, then you will quickly come across a reference to the BIS Guidelines and HMRC’s CIRD manual. So, what are they are why are they important? For most tax relief, the tax legislation (UK Acts of Parliament) contains all important rules and definitions. In the case of R&D, the tax legislation makes reference to the ‘Guidelines on the Meaning of Research and Development for Tax Purposes’ (aka the BIS Guidelines). It defines what R&D is in the context of R&D Relief. This gives them statutory force, which makes them law. Another guidance issued by HMRC in their CIRD manual relates to their internal policies for interpreting R&D tax relief eligibility; unlike the BIS guidelines, the CIRD manual does not have the force of law, although it can provide very helpful insight into how HMRC reviews and interprets one’s claim.
This blog post covers two scenarios relating to Small Medium Enterprises (SMEs) and their ability to claim R&D tax relief: (1) one SME hiring another SME for an item of work; which company has the rights to claim the related R&D expenditures, and; (2) whether an SME that receives funding for its research has an opportunity to make a claim.
First, let’s explore the circumstances of a contractual agreement for work between two SMEs, and the solution to the SME that is eligible to claim R&D tax relief based on its qualified activities. Often, an SME sub-contracts with another SME to deliver a product or a service. In these cases the question arises as to which SME can make a claim; is it the SME that pays for the work, or the one that performs the work? HMRC does not allow R&D tax relief project(s) to be claimed by both companies, therefore, it is necessary to establish which SME is the rightful claimant.
In making this determination, an SME needs to review a variety of factors and arrive at a judgment as eligibility requirements for this are not clearly defined. The main criteria to review and analyze include the following:
- Who owns the Intellectual Property (IP)?
- Who takes the business risk under the contract? Is it a fixed price contract to deliver a finished work product or a time and materials for a service?
Let’s look at an example, whereby SME A contracts with SME B. The contract obligates SME B to provide a software solution that has new or improved functionality, but the specifications of the software design are set by SME A. The contract is set at a fixed price and there is guarantee that the solution will meet certain functional requirements. In addition, in the contract, there is no mention of any discussion about the know-how or intellectual property SME B acquires in developing this software.
Essentially, this contract is for SME A to acquire a finished good. SME B retains any IP it develops or knowledge it has generated from development, and SME B is taking the business risk on the contractual agreement (i.e., if they go over budgeted costs, they are incurring the losses). In this particular circumstance, SME B is the rightful claimant.
Taking the Business Risk And Retaining the Intellectual Property
Conversely, if in the contract it is mentioned that SME A retains the IP where SME B was paid on the basis of time and materials, regardless of whether the software functioned appropriately, and SME B had no right to use the knowledge obtained from the developed solution, then SME A would be the rightful claimant and claim the amount paid to SME B as a sub-contractor expense for R&D tax relief.
The key takeaway from these two examples is that the company taking the business risk and retaining the intellectual property in the context of contracted work is the most likely to be eligible to claim relief. However, there can be cases where this alone is not sufficient to make a determination. For example, what if a company takes the risk but does not own the IP per the contract? In this case, a careful examination of the contract and the circumstances surrounding how the work was actually carried out may be necessary to establish who has the right to claim.
Now, let’s review an example of funded research: An SME that is a sub-contracted party to a non-SME does not own the IP and gets paid on a time and material basis. Can the SME claim a portion of their employee salaried costs for R&D tax credits? For those of you that believe the answer is no, the answer is actually yes!
Some of you might be thinking that I am contradicting what I mentioned above with respect to companies can only claim when it comes bearing the risk of an activity undertaken. So, what has changed in this example? Two things:
- An SME that is a sub-contracted party working on behalf of a non-SME can take advantage of claimed RDEC (Research and Development Expenditure Credit).
- Due to the inability of non-SMEs to claim sub-contractors, the SMEs that are subcontracted can take advantage of claimed RDEC instead of R&D tax credits, even if hired on a time and materials basis.
HMRC considers the above example as funded research, whereby SMEs can benefit an RDEC rate of relief of 8.8% for every pound of research and development expenditure. It is not as nice as the .25% that taxpayers enjoy under the SME scheme, yet SMEs are able to claim both funded research activities in addition to claiming R&D tax credits so long as qualifying expenditures and projects are documented correctly.
If the above examples make you consider claiming, and more importantly, about what you may have not claimed before, get in touch with us.
For a complimentary assessment regarding the issues raised in this blog post, contact A.K. Hajee at (0) 203 002 0089, or email [email protected]
For over 30 years, RDP has been advising businesses and performing R&D claims worldwide. In a 20-minute phone call assessment, we can assess your company’s R&D tax credit eligibility in addition to advising on a range of cash savings.
A.K. Hajee is RDP’s Director of Technical Services and Business Development for the UK market. He has two decades of experience in preparing and educating businesses about R&D tax credits.