Subsidised R&D: everything you need to know

Subsidised expenditure relates to external funding for R&D projects. In recent years, it has been subject to change, both as a result of judicial scrutiny, new HMRC guidance and changes to notified state aid. As a result, anyone who may have an R&D project utilising subsidised expenditure, should ensure that they’re up to speed with the latest requirements. Here, we take a look at the key points so that you have all the latest information at your fingertips.

What is subsidised R&D?

Subsidised expenditure is where an R&D project has funding from source(s) other than the company undertaking the R&D activity. The current format of the SME scheme means that projects with subsidised expenditure are not eligible for the incentive and must claim under the RDEC scheme. 

The term “subsidised expenditure” is defined in section 1138 of the Corporation Tax Act 2009. The legislation provides three areas where a project may be subsidised:

• on receipt of notified state aid; or
• other grant or subsidy; and where
• costs are otherwise directly or indirectly met by someone other than the company.

The latter has caused significant disruption and uncertainty, including tribunal cases. Following the tribunal decisions, HMRC has provided an update to its guidance on subsidised expenditure in its Corporate Intangibles Research and Development manual (CIRD). The guidance doesn’t change the wording of the legislation. Rather, it is HMRC’s interpretation of that legislation in light of the recent cases. The guidance should not be treated as definitive, and the potential for further cases remains, where a taxpayer’s analysis and HMRC’s view diverge.

For accounting periods commencing on or after 1 April 2024, the position becomes moot with the merged scheme legislation removing the definition of subsidised expenditure for the R&D incentive entirely. This simplifies the relief and could result in R&D intensive SMEs becoming eligible for SME tax relief under enhanced R&D intensive support (ERIS) for the first time.

Types of subsidised R&D

As mentioned above, there are three categories of subsidised expenditure:

1. Notified state aid

If a company has received funding which is classified as notified state aid then the whole project, regardless of the level of funding, must be claimed under the RDEC scheme. 

Since the UK left the EU, the presence of notified state aid has reduced, with only companies whose trade interacts with Northern Ireland retaining notified state aid implications. As a result, fewer companies will be impacted by this form of subsidised expenditure meaning there may be more scope for elements of projects to be claimed under the SME scheme.

2. Grants and other subsidies

The above change has moved a lot of companies to the category of a grant or subsidy not under state aid for the first time. In this instance, the project is deemed to be subsidised up to the value of the grant. This is known as a £ for £ deduction. This element would be claimed under RDEC with the remaining allowed under SME. This means that hybrid claims will become more common. Guidance at CIRD81650 reinforces the point: “This may result in the expenditure qualifying for R&D tax relief partly under the SME scheme and partly under the large company scheme or RDEC.”

3. Directly or indirectly by a person

The final category is where funding for an R&D project is otherwise met directly or indirectly by a person other than the company. This is the area that has caused controversy within the incentive and saw HMRC take a significant departure from its previous interpretation of the legislation leading to tribunal cases to resolve the disagreement.

Subsidised expenditure rules for R&D tax relief

As a result of the tribunal judgments, on 27 February 2025, HMRC issued updated guidance on subsidised expenditure within R&D projects. As already noted, the new guidance doesn’t change the wording of the legislation. It simply provides HMRC’s own view of the legislation.

Why did HMRC update the guidance?

The two cases that prompted HMRC to update its guidance on subsidised expenditure were handed down at the end of 2024. They are Collins Construction Ltd v HMRC and Stage One Creative Services Ltd v HMRC (SOCS). Both decisions went in favour of the taxpayer and HMRC did not seek leave to appeal either. It instead conceded its previous restrictive position on subsidised expenditure; namely that any payment under a commercial contract is a subsidy.

The new guidance makes the subsidised test narrower in focus and applies only where a payment is linked to R&D activity. This new approach has been designed to reflect the evolution of judicial thought over several years.

Hadee

While Collins and SOCS represent the latest cases on subsidised expenditure, the journey started five years ago, with judgment in a First-tier Tribunal case called Hadee Engineering Co Ltd v HMRC. Although its application has been limited, it is notable as the first case to consider the subsidised expenditure restrictions (as well as an often linked provision – subcontracted R&D) in relation to SME relief.

Quinn

Quinn (London) Ltd v HMRC – dealing exclusively with subsidised expenditure – followed. It went in favour of the taxpayer (ForrestBrown client, Quinn (London) Ltd), with the judge finding that: “If HMRC’s approach were to be adopted, the circumstances in which an SME could claim enhanced R&D relief would seem to be confined to those where it has no prospect of exploiting the R&D for commercial gain.” 

HMRC decided not to appeal the Quinn decision, but equally did not adopt its findings. Instead, it updated its guidance on subsidised expenditure in CIRD at CIRD81650 to reflect its own view of how the subsidised expenditure restriction should be applied.

This created uncertainty and the potential for further challenge, culminating in Collins and SOCS. The judges in both cases rejected HMRC’s view of how the legislation should be interpreted, prompting HMRC to concede its position. The updated guidelines represent a return to the pre-Quinn 2021 position of a more nuanced test for subsidised expenditure.

What is and isn’t subsidised R&D?

While subsidised is supposed to be considered independently of subcontracted R&D, HMRC’s guidance tries to realign them. It also goes back to the ‘fore-knowledge’ point of what was known at the outset of the contract. This conflates the new rules with old legislation, which is not relevant nor what the tribunal judgments stated.

HMRC has given a rough guide as to what it considers to be subsidised in regard to the meaning of otherwise met directly or indirectly which focuses on the link between what has been funded and the output of the work. This includes funding related to R&D expenditure where nothing is provided in return, meaning that there wasn’t a commercial benefit to the funder. The second is where there is a clear link between the funds and the R&D expenditure for the project. It is also where the focus of the tribunal cases was and is where there could be scope for HMRC to continue to approach the subsidised argument.

HMRC has provided examples of where it would not consider subsidised expenditure to be present. This includes:

– R&D being carried out on the company’s own account;

– the sale of goods or services being as a result of R&D but the sales themselves not having funded the R&D (sales of goods or services prior to R&D being undertaken will not be deemed to have funded the R&D);

– companies obtaining finance on commercial terms to fund R&D; and 

– receipt of payment under a contract but the R&D activities were not contracted to the company.

What this means for grants

Grant funding has previously had a significant impact on SME companies having to claim under the RDEC scheme. It was common for grants to have notified state aid classifications meaning that regardless of the size of the grant, the project was ‘tarnished’ with the work needing to be claimed under the RDEC scheme for the duration of the project. With a lower number of companies being impacted by notified state aid, there is more scope for hybrid claims which could benefit many companies. Where a grant has, for example, 50% funding, it is possible that up to 50% of the qualifying expenditure may be claimed under the SME scheme. 

It is important to carefully analyse your grant contract and ensure the correct treatment is made. A contract review may be helpful in this instance, which ForrestBrown can support.

This is all relevant until the first accounting period that starts on or after 1 April 2024 for companies. AFTER that, the legislation has removed the concept of subsidised expenditure entirely meaning that grant funding and the otherwise met condition becomes a moot point and a company is either under the merged scheme or eligible for ERIS. This could be a big win for a small number of heavily grant funded R&D intensive SMEs who have previously claimed under the RDEC scheme as a result of having subsidised expenditure but will now be eligible for the higher rate under ERIS.

Key takeaways

In light of HMRC’s updated guidance on subsidised expenditure, it is important to review past claims and know where you stand. While the new guidance has limited application, SMEs that considered themselves excluded from the SME R&D regime due to HMRC’s previous restrictive approach should reappraise to avoid missing out on relief in accounting periods still within the window to amend.

What you need to do

Regardless of whether ForrestBrown prepared your original claim, our expert team is able to review your documentation and advise on your position in relation to subsidised expenditure. Having successfully litigated the issue on behalf of our client, Quinn (London) Ltd, we understand the nuances and can help you with your next steps.

Remember, if you’re a grant-funded SME that had previously claimed under RDEC owing to subsidised expenditure, you may now be eligible for the higher rate under ERIS. Whichever category you fall into, we’re happy to bring our expertise to bear.