It is common knowledge amongst the industry that HMRC are focusing on R&D tax credit claims, with a significant increase in enquiries. Historically, claims would be enquired into before any payment was made to the claimant company, which most would agree is a sensible approach. Nevertheless, the enquiry and assessment windows still apply, meaning that whilst it was not common practice for HMRC to do so, they have always had a right to enquire and assess within statutory timeframes. This means challenging an R&D claim after relief has been given (which in majority of cases means the payment of a cash credit).
The complex nature of the statutory definitions and conditions of R&D relief has meant that some claims have contained errors. However, it is also known that some claims have been fraudulent, and as a result there has been a lot of focus on identifying such claims – certainly not an easy task given that over 80,000 R&D claims are submitted annually. It is true that HMRC continue to identify fraudulent claims, so long as enquiries are conducted in a fair and balanced manner, to ensure that those who are genuinely entitled to credits, continue to benefit, without being unduly penalised.
There have been a significant number of cases whereby enquiries are being conducted after cash credits have been paid. It is important to ensure claims are submitted with a high degree of accuracy so that businesses mitigate the risks of being forced to repay HMRC (with the prospect of interest and penalties), at a time when they may no longer have access to the funds. Whilst credit must be given to HMRC in their attempts to identify fraudulent claims, there have been some concerns that some caseworkers are inadequately trained, and appear to be making interpretations which unfairly target companies whose activities are genuinely within the remit of R&D.
In this article, we will cover some of the complexities and issues with R&D tax, and why it is important to seek professional guidance.
Claiming under the wrong scheme
One issue is where companies claim under the wrong scheme. It must be emphasised that for a claim to be made under the small to medium-sized enterprise (SME) scheme, it is imperative that the staff headcount, and financial metrics (turnover and gross assets) are observed. These apply on a “group” basis with complex rules for “Partner” and “Linked” enterprises. Furthermore, there are complex rules where the size of a group changes from period to period. Usually, the status must be observed for 2 financial periods. For example, a company which is an SME in year one will continue to be an SME in year two, even though it may have organically grown to exceed the staff headcount and financial metrics. However, in the case of a merger or acquisition – which pushes an SME into the “large” entity bracket – the company will be large in the period of acquisition or merger.
Further complexities arise where expenditure is subsidised, or the project has received state aid funding. Where a project receives state aid funding, it’s not possible to claim R&D relief under the SME scheme (which itself is a form of state aid), due to there being strict restrictions on claiming more than one state aid. Claims must therefore be made under RDEC (which is not considered state aid), and this will also apply to all future claims on the same project. Care must therefore be taken to ensure that the merits of receiving any funding outweigh the loss in R&D tax relief from switching schemes. The grant paperwork will usually confirm whether the funding is notifiable state aid. However, some grants will be labelled as de-minimis, which would mean that it is not notifiable state aid. Where this is the case, if the funding is used to cover R&D expenditure, then the part which has been subsidised would be claimable under RDEC, whilst the remaining expenditure will continue to be claimable under the SME scheme. Planning is therefore essential to ensure that the status of any grant is determined from the outset. If a grant is state aid, it may be possible to ringfence this towards one R&D project or sub-project (so that the other projects continue to benefit under the SME scheme). If a grant is not state aid, it may be possible to ringfence the funds towards non-R&D qualifying expenditure (so that the qualifying expenditure for R&D tax relief purposes is not subsidised). It should also be noted, that, under the SME scheme, a company cannot be subcontracted to undertake R&D activities. However, in certain instances, it may be possible to claim under RDEC.
Paying for R&D expenditure
Another issue surrounds the concept of “payment” and whether R&D expenditure must be paid for. With the exception of consumables and software, R&D expenditure must be paid for. This applies to staffing costs, subcontractors, externally provided workers, clinical trial volunteers and contributions to independent research (for large companies). HMRC are of the view that payment does not necessarily need to be made before the year end, but it should be made before a claim is submitted (which is interesting given that a First Tier Tribunal judge in the historic case of Gas Recovery & Recycle Ltd stated that payment must be made before the accounting year-end). Furthermore, complexities arise where one group member (which could include a Parent), makes payment on behalf of the claimant company. We have seen HMRC challenge situations where despite the fact that payment has been made for the expenditure, it has been made by another company on behalf of the claimant, with the balance left outstanding inter-company. Their challenge is that the claimant has not paid for the expenditure, and therefore cannot be entitled to claim R&D relief. However, had the claimant borrowed funds from another entity, and used those funds to make payment, this wouldn’t appear to be an issue. The economic reality of the situation has not changed, but the fact that a payment is made directly from the account of another entity (perhaps due to administrative reasons), appears to create a risk for a claimant company. Care must also be taken where payment is in the form of non-cash, such as the issue or transfer of shares, assets or the release of a debt.
Claiming capitalised expenditure
Further complexities arise where expenditure is capitalised in the accounts. For expenditure to be claimable, it must be allowable as a deduction in computing the profit or loss of the trade. In most cases, this means expenditure would be shown as a deduction in the P&L. However, it is possible (s.1308 CTA 2009) for a company to claim a full deduction for expenditure which has been capitalised as an Intangible Fixed Asset (IFA), for the period in which the additions are made. The result of this is that one could treat such capitalised expenditure as claimable for R&D purposes, despite the fact that not all of the expenditure is shown as a deduction in the P&L. However, care must be taken to ensure that amortisation is disallowed to avoid duplication (which also applies to all future periods). This can be tricky, especially where there is some IFA expenditure which does not qualify for a s.1308 deduction under the R&D rules, and therefore the amortisation on this would be allowable subject to the normal IFA provisions. The result is that there may be some amortisation which is allowable, whilst the remainder may not. Detailed computations must be obtained to ensure the correct treatment going forwards. However, there is no such s.1308 equivalent for R&D expenditure which has been capitalised as a Tangible Fixed Asset. In such cases, the amount qualifying for R&D tax relief is limited to the amount charged to the P&L by way of depreciation. This could heavily restrict any R&D claim.
Group R&D arrangements
Complexities can also arise in group R&D arrangements. Firstly, R&D must be “relevant” for the trade carried on by (or to be carried on by) the claimant company. The undertaking of R&D alone is not a qualifying activity for this purpose. This could be addressed by charging for any IP development on an arm’s length basis, but it is essential that care is taken to ensure that a claim is made by the right company. Furthermore, there are complexities where one group entity invoices another in respect of connected subcontracting. A restriction applies to the amount claimable for R&D (lower of the connected subcontractors’ qualifying R&D expenditure excluding any further subcontractors, and the payment made to the connected subcontractor entity). It must be emphasised that without any payment, the amount claimable is nil. Furthermore, if the connected group subcontractor’s expenditure consists of any further third-party subcontractors, then this amount is not claimable (and hence the need to ensure that contractual relationships are with the correct entities). A recharge of costs between group companies also has its challenges. A recharge of staffing costs of Company A to Company B, does not mean that these are the staffing costs of Company B. However, they may constitute Externally Provided Workers if the conditions are satisfied, albeit there may be further restrictions where individuals are employees / directors of both group entities.
The above addresses some complex matters involving R&D tax relief, but there are many other complexities. For instance, is there actually a project which seeks an advancement in the field of science or technology? Are there uncertainties which cannot easily be resolved by a competent professional? Does the advancement extend beyond the company’s own state of knowledge or capability? Hopefully, this article reinforces the message that specialist guidance should be sought before making an R&D claim, and advice should be sought from the outset to ensure that affairs are structured with a view to mitigating risks.
Gravita works with many accountants and their clients to provide technical R&D support and guidance. This includes constructing R&D claims from scratch, reviewing R&D claims prepared by other firms, as well as handling HMRC R&D and other tax investigations.
If you need help or advice with your R&D tax, don’t hesitate to get in touch with one of our experts today at email@example.com.