Following the judgement’s publication, HMRC has continued to challenge some SME R&D tax relief claims on this point, creating uncertainty for businesses and advisers. We remain hopeful that a positive resolution can be reached. But while uncertainty persists, there are practical steps that businesses should take now when considering their R&D claims.
R&D tax relief rewards UK businesses for investing in innovation. For taking risks, for hiring, for investing in their future business growth. The policy is designed to be a catalyst for private investment in R&D.
Successive governments have backed and bolstered the incentive since it was introduced in 2000. And over the last few years, the incentive attained a new impetus as the UK adapted to life beyond EU membership and post-COVID.
On the surface, the narrative around R&D investment remains positive, with the government pushing its desire to turn the UK into a science superpower. But at a tax policy level, things have soured somewhat. In recent years, HMRC has come under increased pressure from the Treasury to clamp down on what is seen to be widespread error and abuse of the R&D incentive.
This pressure comes all the way from the top. Chancellor Rishi Sunak has publicly lamented the discord between what the incentive costs and the reported level of private sector investment in R&D. According to Sunak’s Mais lecture address, business spending on R&D amounts to just four times the value of R&D tax relief. The OECD average is 15 times. It’s clear that there is work to be done to ensure that the incentive operates as intended.
As I’ve written before, I agree that fraud, error and boundary pushing, fuelled by malicious and unregulated agents, are problems in the system which require urgent solutions. This problem is widely accepted among business groups and the tax policy community. There’s no point in denying reality.
But – and this is a big ‘but’ – we disagree with where HMRC has directed its efforts on remedying the situation. In particular, its newly narrowed interpretation of contracted out and subsidised R&D.
This focus may lower the overall cost of R&D tax reliefs to the government. But it will be at the expense of providing vital funding for genuine R&D activities. It’s also at odds with the policy intent of the incentive.
The situation: the Quinn tribunal and HMRC’s arguments
Our client Quinn is a construction firm with a specialist heritage division. The company prides itself on its ability to take on and deliver complex projects.
Through these projects, Quinn frequently develops new techniques, materials, and methods. And while this innovation has a specific client in mind, it also gives the company an edge when competing for future projects.
In other words, R&D tax relief is performing as intended: allowing and encouraging the business to take on risks in accepting complex jobs, pushing the company forward in its technological capabilities, adding to its bottom line, and creating more work (and jobs).
But HMRC had a different perspective. It argued that it isn’t fair for Quinn to receive R&D tax relief when in most cases – although, notably, not all – Quinn was able to recoup its investment in R&D through the price its clients paid for the work delivered.
HMRC considered that Quinn’s R&D had therefore been ‘paid for’, or subsidised, by its clients. In R&D tax law, subsidised R&D is excluded from SME R&D tax relief. In Quinn’s case, HMRC denied relief worth over £1m.
The update: The Quinn judgement and HMRC’s response
In our view, HMRC’s interpretation fundamentally misunderstands how R&D works in a commercial context. Judge Harriet Morgan agreed in dismissing its arguments and finding in favour of Quinn.
She commented that it would be “wholly out of kilter” with the intention of the incentive if an SME were to be denied relief simply for seeking to recover its R&D costs through its commercial arrangements.
As with any First-Tier Tribunal case, HMRC did have the option to appeal the decision. An appeal would have provided a binding precedent on this point.
However, HMRC has said that while it disagrees with the judgement, it has chosen not to appeal the case. It has formalised this position by updating its online guidance manual, ignoring the Quinn judgement.
HMRC has also been quite clear that it intends to continue to pursue its narrowed interpretation of subsidised R&D. As such, it may challenge R&D claims where the facts are similar to Quinn.
What does this mean for you?
For tax advisers, the Quinn judgement provides a detailed analysis of the law on this point. Which, in turn, helps provide advice to businesses. However, without agreement from HMRC, there is still uncertainty for businesses seeking to access SME R&D tax relief.
The tribunal outcome has not yet resolved the wider issue and we welcome further dialogue as the most effective and efficient means to resolve this point. Without that dialogue, we would expect there to be further tribunal cases.
Tax cases dealing with R&D are still rare, although businesses have a poor track record when it comes to successfully challenging HMRC. In 12 cases, the taxpayer has succeeded only four times. The tribunal process is also lengthy, taking many months or even years.
Few R&D tax advisers have experience supporting a client through the tax tribunal process and in some of these cases, businesses and their advisers have underestimated the difference between dealing with an HMRC enquiry and a tribunal.
It’s important to understand that disagreements between taxpayers, tax advisers and HMRC do happen. Most of the time, everyone works to a common understanding of the legislation. However, given the complexities that can arise from each specific case, there is scope for differences of opinion.
The tribunal system is there for taxpayers to resolve such disagreements through the courts. But there are many other examples of disagreements being resolved through stakeholder engagement, usually resulting in updated guidance to crystallise the agreed way forward.
In the meantime, if your business could be affected – or if you are advising a client who could be – you need to understand your risk profile. This will help you make informed decisions about your claim.
If you’re facing this issue and would like to discuss it in further detail, please don’t hesitate to contact us.Get in touch
What happens now?
It is in no one’s interest for this uncertainty to continue indefinitely. Further tribunal cases might help – but that process is lengthy and costly for all involved. The best way to find a resolution and protect genuine innovative businesses is through discussion and clear guidance.
The onus, for everyone involved in this debate, is to ensure the UK remains a competitive location for cutting edge research. Especially at a time where businesses are facing acute uncertainty in supply chains and labour shortages. The incentive is designed to instil confidence, so any uncertainty risks diminishing that confidence.
The long-running consultation on the future of R&D tax relief continues and there have been calls to bring this issue within the scope of that consultation. This would enable legislation to be changed to provide certainty (if needed) and ensure the policy intent of the incentive continues to be met.
As it stands, this dispute distracts from real problems at hand: error, fraud, and rogue R&D agents. HMRC and reputable agents should work together in addressing these important issues.
What’s needed now is dialogue. Everyone – government, businesses, advisers – wants the incentive to work. And by working together, we can make R&D tax relief fit for the future.