Jenny Tragner is a Director at ForrestBrown and sits on HMRC’s research and development (R&D) Consultative Committee where she provides input on major policy consultations leading to new legislation.

With more than one year of the Finance Act 2015 behind us, we picked her brains over the changes to the treatment of consumables in R&D tax credit claims, which was an issue that had rumbled on for many years.

Jenny, could you start by explaining what consumables are in the context of R&D?

Yes, it’s simpler than it sounds. It relates to materials that are used or transformed during R&D. As well as production materials this includes the utilities of water, fuel and power. As you can imagine, they are particularly relevant to manufacturing, engineering and construction businesses.

What has the consumables furore been all about?

Ten plus years ago, companies could embark upon a consumable heavy R&D initiative, for example a large scale manufacturing trial, put in an R&D tax credit claim for the whole cost of materials, and then go on to sell whatever they produced. Essentially, they were getting paid twice for the same work. The legislation at the time permitted it, but HMRC increasingly felt that the practice was not within the spirit of the rules. Something of an impasse followed as industry and HMRC tried to agree a mutually acceptable solution. It took until 2010 for new guidance to be published. The new guidance went some way to halt the previous practice, but primarily represented an uneasy compromise between the two positions. Fast forward to 2015 and we were given legislative clarity.

And could you explain that clarity in 60 seconds?

Let’s consider three scenarios. First is high volume manufacturing. If you sell the output of the R&D project, you cannot include the consumable costs of the input in the claim. The best you can hope for on this project is to include the consumables that ended up as wastage.

The second scenario is prototypes. These remain fine for including in a claim with one important caveat. Their purpose must be confined to R&D. So, if the prototype is built to be used as a demonstrations model or an exhibit at a trade show, that would prevent it from being included in the R&D tax credit claim.

Finally, we have ‘first of class’ production. This relates to high value items that would be impractical to produce in prototype form: skyscrapers, superyachts and the like. It recognises that such projects will contain a mixture of innovation and existing knowledge and technology. Previously, the guidance allowed individual R&D projects within the larger builds to be identified and associated consumables claimed for, however these costs have been completely caught out by the ‘not for sale’ part of the new rules.

That was close enough, well done!  What is the impact of the 2015 rules on consumables?

It’s relatively early days, so we will have to wait a bit longer for the complete picture. What we can say now with confidence is that it will have hit some sectors hard because it removes one of the largest components from their R&D claims. I’m talking about the same ones I mentioned before: manufacturing, engineering and construction.

What is left for these companies to claim on consumables also becomes more onerous to identify as they potentially have to pick through data with a fine tooth comb in order to ensure that they comply with the rules.

This bad news is tempered by two things. What had been a source of rancour and a grey area for HMRC, advisers and companies is now much clearer. Secondly, these restrictive changes were delivered in the same package in which the rates of relief were made more generous across the board, meaning that most companies that claim will see a modest net gain if they are unaffected by the new consumables rules.

Any tips for companies who are claiming and have significant consumable costs?

Record keeping! It’s my mantra for everything R&D. The better records you keep from the outset, the more an adviser like ForrestBrown will be able to optimise your claim. For instance, at an R&D stage you will tend to buy materials in smaller quantities and can pay a premium for this. If your records are good enough to ring-fence these higher costs, then they can be applied to an R&D tax credit claim whether full or partial consumables are allowed.