In a new finding by the First Tier Tribunal, HMRC has suffered a blow in its attempt to limit the scope of R&D tax credits.

The win, by the construction firm, Quinn (London) Limited has clarified an area of the legislation that was somewhat opaque.

In the case, Quinn (London) Limited v HMRC (TC/2020/01846), the Tribunal found in favour of the taxpayer, meaning that they are able to claim tax credits on the value of their research and development activity to the value of more than £1m.

What are the R&D tax credit rules?

As it pertains to this case, the R&D tax rules require a company to carry out their work with a significant level of doubt around the outcome.

This means that they bear the risk and rewards of the outcome of that research.

This is in contrast to research companies that are specifically paid to research on behalf of a customer and that would get paid, whatever the outcome.

However, a recent tightening of the rules by HMRC has meant that they are taking a much closer look at the issue of subsidies.

Where companies are subsidised for the work on their R&D, then they are not able to claim tax credits. A particular bone of contention, in this case, was the interpretation of the phrase “directly or indirectly”.

According to HMRC, this was inserted into the legislation to ensure that companies didn’t contract for R&D work and then pay through a third party. This seems to us an entirely reasonable defence against fraud.

However, HMRC appears to now be trying to take a very broad interpretation of ‘indirectly’ in that they seem to think that the ordinary activities of a company can constitute an indirect subsidy, even when a contract for R&D services doesn’t exist.


R&D tax credit subsidies – an example

Take Company A, a business that provides water pumping systems for housebuilders. They have an idea to develop a new form of pump that will radically advance the industry and provide significant benefits for their customers.

They have a lot of diverse developers who buy from them and Company A hopes that when the R&D is completed it will be able to sell to them across the board.

In this instance, there is no subsidy. Company A is taking all of the risks and investing its own money in the hope that it may be able to sell in the future.

Contrast this with Company B that is in the same industry. It is contacted by one of its customers who ask it to specifically develop a pumping solution for their situation.

The customer pays a percentage of the development costs to Company B to carry out the development and Company B hopes to also sell it to other developers when it is complete.

In this instance, there is a subsidy, as Company B is being paid directly to carry out the R&D meaning that a significant proportion of the claim would be disallowed if not all of it.

 

The Quinn case

The Quinn case falls somewhere between the two stools.

Quinn is a development and refurbishment company that provides services to customers and gets paid on an instalment basis. The payments aren’t linked directly to expenditure but are ‘stage payments’ that form a percentage of the total development cost.

In this instance, Quinn carried out innovative R&D work during contracts that they then hoped to sell to the rest of their customer base once completed.

HMRC argued that this was a subsidy, as part of the risk had been reduced in respect of Quinn’s development costs as they were being paid by customers at the time.

However, Quinn argued that the contracts with their clients were for refurbishment and development and related purely to that outcome. The fact that at the same time Quinn developed new ways to do the work was immaterial and not related to any payment by the customer.

Their argument was that the R&D tax credit scheme was specifically designed to assist companies that wanted to improve their prospects of carrying on their trade or profession and so it is entirely reasonable that whilst doing so they also work out new ways of providing their services.


Where is the risk?

There’s an important point in this case that may prove useful for readers in the future.

In the Quinn case, there was no sign of any link between the design and research hours expended and the eventual contract with the customer.

In short, this appears to bolster the argument that the risk was being borne by the company rather than the customer.

So although Quin was developing their services with future sales to customers in mind, their current customers weren’t paying for the research and if it didn’t prove to be viable, then there would be no payment made to Quinn for the sunk costs.

The invoices paid by their customers were purely for refurbishment work and not R&D.

Another important point is that there was no requirement from any of their current customers to develop new methods when the contracts were signed. In essence, the R&D that was done was a by-product of the contracts and not the aim.

The Tribunal found that for R&D tax credits to be subsidised, the customer would have to have met the cost of the R&D expenditure through direct or indirect payments with a clear link.


What does this mean for companies in the future?

The FTT ruling means that HMRC’s attempt to limit R&D tax credits is being rolled back.

Whilst we fully support the fight against fraud and incorrect R&D tax credit claims, we have to say that making a lawful claim more difficult is not exactly encouraging businesses to invest in new technology.

So this judgement means that the interpretation of subsidies is just that little bit wider, opening up R&D tax credits for more businesses.

For SME’s R&D tax credits form a really important method of raising cash without dilution of equity which in turn promotes innovative thinking.

For businesses carrying out R&D work, it is important to make sure that your activities are properly segregated to enable an R&D tax credit claim to succeed.

It is vital that there is no link between your R&D expense and any payment by customers otherwise that could be seen as a subsidy.

The final value of invoices shouldn’t be linked to the outcome of any R&D work and the product of that work should be useful for sales to all of your customers rather than just one.


Doing R&D work?

If you are carrying out R&D work in your business then you’ll know how frustrating it is to have to wait for R&D tax credit payments.

Rocking Horse Finance specialise in providing alternative financing for SMEs including future R&D tax credit claims giving your cash flow a welcome boost and enabling faster development.

Call us now and find out how we can help your company.


CONTACT US

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Toby Walker
+44(0)7804132386
toby@rockinghorsegroup.co.uk

UK:
James Davis
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james@rockinghorsegroup.co.uk

Australia:
Giles Karhan
+61(0)411622414
giles@rockinghorsegroup.com.au