Confusing Times for R&D Tax Relief
Research and Development (R&D) can take many forms for different companies. It may be the development of a new product, or perhaps research into competitor behaviour. For some, it may be the creation of new procedures to ensure the business operates with greater efficiency. All businesses perform R&D to some degree – but to qualify for R&D tax relief, a company has to meet certain criteria. There has always been an element of confusion over what qualifies for R&D tax relief, but recent HMRC conduct has seen the seeds of doubt sprout into fully grown worry trees.
The definition of qualifying R&D for tax purposes is currently a contentious issue for claimant companies and their advisers. Many companies which regard themselves as ‘genuine claimants’ of R&D tax relief are currently embroiled in lengthy and protracted HMRC enquiries which often centre on whether the company’s R&D meets the definitions, as outlined in HMRC’s guidance manual. There is no doubt that many companies (and their advisers) have pushed the definitions of qualifying R&D to their limits in recent years. However, there has been widespread online discussion in recent months about HMRC’s apparent move towards denying claims, when it is patently clear that R&D definitions are being met. There is a growing feeling amongst businesses that genuine claimants are being swept up as collateral damage during HMRC’s purge of more questionable claims.
So, what are the definitions?
The definitions of R&D for tax purposes can be found in HMRC’s guidance manual: CIRD81910 - R&D tax relief: conditions to be satisfied: DSIT Guidelines (2023). The 2023 Guidelines replaced the 2004 version and apply to accounting periods beginning after 31 March 2023. The Guidelines they replaced (the 2004 version) are largely similar, with any changes being outside the scope of this article. It is relevant, however, that the Guidelines are not a statute or a contract and should not be interpreted as if they were. Rather they should be interpreted objectively in accordance with the language used and in their proper context.
The ’core’ definition of R&D for tax purposes is a project which seeks to achieve an advance in science or technology. The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D. These two requirements (advancing science/technology and resolving scientific/ technological uncertainty) and the fundamental requirements of the relief. However, we can dig a little deeper to gain a clearer understanding.
As per the guidelines, an advance in science or technology means an advance in overall knowledge or capability in a field of science or technology (not a company’s own state of knowledge or capability alone). From this, is clear that simply improving a business’s own technology capability is not sufficient. The wider technological baseline should be considered.
Paragraph 9 – Helpful. Or Maybe Not?
The Guidelines are further helpful in outlining the manner in which an advance in technology may manifest itself. The guidelines at paragraph 9 state:
A project which seeks to, for example,
a) extend overall knowledge or capability in a field of science or technology; or
b) create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or
c) make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or
d) use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way (e.g. a product which has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner) will therefore be R&D.
This section of the Guidelines is one notable source of controversy. In recent years, HMRC have argued that projects which meet one (or more) of the above requirements do not necessarily qualify for the relief. In one particular enquiry case, known to the author of this article, HMRC suggested that although the claimant company’s projects led to appreciable improvements to existing systems through technological change (as per point d in the Guidelines above), they did not involve an advance in technology. That is to say, HMRC’s interpretation of the guidelines is that paragraph 9 does not give examples of matters which amount to an advance in science in technology.
This somewhat confusing position is contradicted by a recent First Trier Tribunal (FTT) case involving the company, Glazer Learning Limited. The Tribunal’s reading of the Guidelines in the Glazer case is at paragraph 6(3) where it is stated that (italics added):
(3) for the purposes of paragraph 6(1)(b) above:
(d) the following are expressly stated to amount to an advance in science and technology:
(iii) a project which seeks to make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes
We therefore have an odd contradiction between HMRC’s apparent approach to paragraph 9 of their own guidelines. It is a matter of plain English that the guidelines have been drafted to consider an appreciable improvement through scientific of technological change as representing an advancement in science or technology. However, it seems that HMRC are not adopting this view on all cases.
HMRC’s interpretation of the Guidelines is surely incorrect on this point and the approach of the FTT should be preferred. Considered properly and in context, “an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes” (paragraph 9(c) of the Guidelines) is an example of an advance in science or technology. This is plain from the context in which the example is given. However, it would appear that HMRC do not agree.
Blunt Force Tactics
Whilst the above is an example of how HMRC have attempted to deny claims based on technicalities and interpretation of the Guidelines, it is clear they are increasingly adopting far less sophisticated tactics. In recent months, many claimant companies have been denied claims without any technical justification. HMRC are denying claims by just saying ‘no’. Occasionally, a cursory explanation from the Inspector as to why the claim has been denied may be given (example: I have Googled this technology and it already exists, therefore the project is not qualifying R&D).
This is clearly not satisfactory and indicates that HMRC have almost entirely abandoned certain statements which are included in their own guidance. The Guidance (CIRD80525) informs claimant companies that HMRC will be sympathetic and supportive when dealing with queries from companies or when making enquiries into their claims. In one particular case which is the author is aware of, HMRC were challenged on their adherence to the statements set out in CIRD80525. HMRC responded, in writing, that the sympathetic approach to claims, and the notion of consistency and certainty (all set out in CIRD80525) would not be adhered to because the enquiry was not opened by a specialist HMRC R&D unit, and therefore the normal rules of engagement didn’t apply. The irony of course is that the specialist R&D units no longer exist – but HMRC’s guidance still includes statements about consistency, certainty and their sympathetic approach to claims.
Another common tactic which seems to be currently employed by HMRC is simply ignoring evidence which has been provided. In multiple cases, HMRC have been provided with detailed descriptions of the R&D, and how it meets the qualifying criteria set out the BEIS Guidelines. What follows is a letter from HMRC requesting information which is almost identical to that which has been provided in the previous response. Letters from HMRC are often templated and occasionally, reference other cases which HMRC have been working on. Apart from the obvious data protection and confidentiality issues at play, it also serves to frustrate and stifle progress in achieving a satisfactory outcome.
HMRC’s current approach to R&D tax relief is markedly different to that of yesteryear. Few could argue that change wasn’t required. From the mid-2010s onwards, online discussion and content was filled with enraged accountants bemoaning the fact that their clients had been targeted by unscrupulous ‘specialists’. Projects such as installing new bike storage space, creating new menus, and purchasing off-the-shelf software were all, according to ‘specialists’, qualifying activities. Reputable advisers demanded change; more checks, more enquiries, targeted resources towards known bad advisers. HMRC have responded. Today there are more checks, more enquiries and advisers which were known for their liberal interpretation of the definitions are undoubtedly being targeted. Whilst this is welcomed by most, there is a growing consensus that the new approach is not being implemented correctly. As one client, scarred by a recent (but ultimately successful) enquiry, recently quipped, “it’s just not worth claiming any more, what with all the b*llocks that comes with it”.
Something isn’t right.
YesTax. Positively Better.