R&D tax relief: the payment requirement
In recent months, YesTax has handled two cases where claims submitted to HMRC by other advisers had fallen foul of the regularly overlooked payment requirement rules. Our director, John Moxon, explains all.
Determining the eligibility of R&D expenditure for the purposes of claiming R&D tax relief can often be a complicated undertaking. The basic requirements are set out at CTA 2009 s1044 (5) which states that expenditure must be allowable as a deduction in calculating for corporation tax purposes the profits of the trade for the period. In layman’s terms, the expenditure must be relevant to the company’s trade and must be reflected in the financial statements of the period under observation.
At YesTax, we regularly ask for evidence of where certain costs appear in the financial statements. Often, we’re provided with a nominal code breakdown from the client’s accounting system which indicates where the cost has been posted to. It’s normally safe to assume that if the cost is being posted in the financial statements and falls into one of the qualifying cost categories, it will meet the requirements set out at CTA 2009 s1044 (5).
In recent months, we’ve been asked to give out opinion on two separate examples of where HMRC had opened enquiries into R&D tax relief claims not prepared by YesTax. The first involved a claim which had been assembled by the company itself, with no specialist advice being sought. HMRC had identified two large transactions – for subcontracted R&D work - which formed over 90% of the claim costs. HMRC requested further details of the work undertaken and evidence that the invoices had been paid by the claimant company.
Both the accountant and the directors of the claimant company were unsure as to why HMRC had requested evidence of payments. The costs were for subcontracted R&D work – a qualifying cost under the SME scheme – and both invoices were posted in the profit and loss account of the claimant company in the period the claim was being made for. Despite this, neither invoice had been paid and there was little expectation that the invoices would be paid in the near future.
The claimant company directors and the accountant who advised on general tax matters for the company were not aware that for an R&D claim cost to be valid, it must have been paid by the time the claim is submitted to HMRC. This is outlined is HMRC’s R&D tax guidance manual at CIRD81200. The manual states
Where the underlying legislation requires not only that there be expenditure, but also payment, this means that the amount must actually be paid. While the payment in these circumstances need not have been made by the end of the accounting period in which the expenditure is shown, it must have been made before the claim to R&D tax relief can be valid.
Reliance on HMRC’s guidance alone is not recommended, so an examination of the legislation is essential. As previously mentioned, the costs referred above were categorised as subcontracted R&D. CTA2009 S1133 (1) states
In this Part a “sub-contractor payment” means a payment made by a company to another person (“the sub-contractor”) in respect of research and development contracted out by the company to that person.
The explicit reference to payment is not accidental. The word is intentionally used and HMRC will routinely disallow costs included in claims if they have not been paid by the time the claim is filed. It is a regular ‘checklist’ point for HMRC’s R&D inspectors and will certainly be examined during enquiries. References to the word ‘payment’ are also found in the legislative sections for staffing costs and externally provided workers.
In another recent case, YesTax was approached by an audit firm which was preparing the CT return for a client who had sought specialist R&D tax relief advice from a third party. The audit firm wanted additional assurance over the claim, given that the reduction in tax charge generated by the claim was material to the financial statements.
This particular R&D tax claim included a significant amount of connected party externally provided workers costs which had been charged by another group company. As with the first case discussed above, the costs appeared valid and had been correctly included in the financial statements of the claimant company. However, the costs had not been paid and were reflected in a large inter-company loan account on the balance sheet of the claimant company. There was no likelihood that the costs would be paid in the short to medium term future. Our advice was that in line with HMRC’s guidance and the explicit references to payment at CTA2009 S1129, the costs were not valid and should be removed from the claim. Surprisingly, the adviser responsible for assembling the claim argued that ensuring costs had been physically paid fell outside their scope of responsibilities.
The payment requirement rules can often be disregarded when assembling a claim. Many claims are assembled long after the year end, meaning that costs included in claims will nearly always be paid, given that most suppliers offer trade terms of between 30-60 days and wages are normally paid within a month of them being posted to the financial statements. However, where a claim is prepared and submitted shortly after the year end, or there are large value invoices which form a significant part of a claim, it’s always worth checking that the expenditure has actually been paid – otherwise there could be a nasty surprise awaiting.