When it comes to R&D tax credits under the SME scheme, the area of contracts and subsidies is very complicated, confusing and often misunderstood.
HMRC knows this and has a current campaign to review SME R&D tax credit claims that are likely to run afoul of these rules. If you are a manufacturer or software developer doing bespoke work for a client, where such work qualifies as R&D, you need to be very careful.
To get technical, s1053 of the Act is the culprit . The wording of this legislation is vague.
What the legislation states is that any R&D expenditure, incurred by a company will not qualify if the expenditure relates to activities which are contracted out by the company by any person. In addition, the expenditure will not qualify if it is subsidised. HMRC has taken subsidy to mean not just a government grant but any proceeds the company may have received toward a bespoke contract.
So lets say you are a manufacturer and you are developing a bespoke piece of equipment for a UK customer. The customer is buying a piece of equipment and under the terms of the contract, the customer is paying a fixed price with guarantees and warranties, and you own any IP developed.
In this scenario, HMRC would likely argue that the proceeds received under the contract would preclude you from claiming any costs related to R&D work under the SME scheme. Failing that argument, HMRC would also likely argue that the amount received is a subsidy, so either way there is no claim under the SME scheme.
The same scenario would apply if it were a software company developing bespoke software for a customer.
It is our belief that there are many companies out there that get caught up by these rules.
The purpose of this legislation is to prevent 2 UK SME’s from making an R&D tax credit claim under the SME scheme. In other words, it is fair to say that it should not be that both the payor (Customer) and creator (You) can make an R&D tax credit claim for the same work done. However, because the legislation is vague, it can be interpreted with unintended results.
For example, it could be interpreted that any revenue received by any company could be treated as either a contract payment or subsidy. This would then mean any company that earns revenue is precluded from making an R&D tax credit claim under the SME scheme.
Clearly this is not the intention of the programme nor a reasonable interpretation of the legislation.
So how do you deal with this?
The further you can distance the R&D work done from any revenue earned under a bespoke contract, the better. For example, perhaps the contract could say any R&D work undertaken by the creator, is not covered by the fees paid by the customer.
This is a very tricky area and one that affects a large number of companies submitting R&D tax credit claims under the SME scheme.
For more advice on how to deal with this situation, please contact us at [email protected]