Key points
- HMRC lost on both points
- On subsidised expenditure, the judge found no reason to diverge from Quinn and, since the fact pattern was similar, adopted it in line with “judicial comity”
- On contracted out expenditure, the judge again referred to some of the principles in Quinn and determined that a “broad interpretation” of the relevant legislation was not appropriate
Background
Collins Construction Ltd v HMRC [2024] UKFTT 951 (TC) involved an enquiry into two years of R&D tax relief claims, amounting to over £3 million in tax. There was no dispute about the nature of the R&D activities themselves or the amount of expenditure, which were all agreed.
There were two matters of law involved in the case. First, whether the company’s expenditure was “subsidised expenditure” within the meaning of section 1138 of the Corporation Tax Act 2009. Secondly, whether the activities had been “contracted out” to the company within the meaning of sections 1052 and 1053 of the CTA 2009.
Two witnesses appeared for HMRC: one to give evidence on the history of the statute and on HMRC’s view of its purpose; and the other to give evidence on the background to the assessments. Since this evidence did not assist the Tribunal in determining the facts about the way the business was conducted, the Judge felt that this evidence was of little evidential value.
Two witnesses gave evidence for the company in respect of the contracts and the way in which the business was run.
The Tribunal found as fact at [24(10)] that: “The contract between Collins and their clients requires Collins to deliver a specified product in return for an agreed sum and design the way in which to provide the end product. There is no contractual requirement or provision for R&D activities. Collins retains any intellectual property rights relating to their innovations during a project (subject to the client’s right to specific use) and takes the economic risk in producing those innovations. There is no provision for adjustments to provisionally agreed sums for such innovations.”
Discussion
The subsidised condition
Subsidised expenditure has previously been the subject of litigation in the Tax Tribunal, in Quinn (London) Ltd v HMRC [2021] UKFTT 437 (TC). While HMRC did not adopt the judgment in its guidance, the Judge considered Quinn at length in this decision.
HMRC argued that since Quinn was an FTT decision, it was not binding on the Tribunal. There was also some discussion on the principle of “judicial comity”, whereby equivalent courts should follow a decision of a similar level of court unless they believe that decision to be wrong.
The parties were invited to provide representations on this issue, and on an FTT decision – Redevco Properties UK 1 Ltd v HMRC [2023] UKFTT 655 – where this principle was considered. The company submitted that the arguments in its case were the same as those in Quinn, and HMRC had not shown that Quinn was wrong “by just reiterating the same points in identical circumstances.” HMRC submitted that the test was that the Tribunal should follow a “court of coordinate jurisdiction” unless satisfied it is wrong, and that simply disagreeing with the reasoning of the prior decision makes it wrong.
The Judge considered that they had no reason to dispute the decision in Quinn. The Tribunal noted “striking similarities in both cases” and went on to specifically refer to numerous parts of the Quinn judgment, which it believed relevant and with which it agreed. The Judge also noted the Upper Tribunal decision – HMRC v Perenco [2023] UKUT 169 – endorsing Quinn. She was satisfied that the UT was aware of the different statutory regimes when they referenced Quinn – dismissing that line of argument from HMRC. In finding in favour of the company, the decision states: “We also consider that the circumstances of this case and Quinn are far removed from those which are intended to be captured by section 1138(1)(c) on a fair reading of it in the context of the whole of section 1138 and the overall SME scheme.”
Contracted out condition
The Judge found, in [67] that the contractual bargain was for the company to provide works for the client for an agreed price and that the price may or may not cover the expenditure incurred. The Judge also stated that the company “has the ownership rights to any fruits of the R&D”, and therefore the bargain made is not for Collins to undertake R&D activities on behalf of the client.
Having identified the contractual obligations, it was then necessary to see whether these obligations fell within the legal description set out in section 1052 of the CTA 2009.
HMRC argued that an SME could claim if it met the conditions in section 1053 of the CTA 2009; that the provisions were there to prevent SME relief being given in respect of large companies; that the provisions were there to prevent double claims and to restrict the claim to the Principal; and, if no one could claim in respect of particular R&D, it is wrong to assume that one party should be able to.
It also argued that the purpose of the contracted out condition was to confine the right to claim SME R&D tax relief to the principal in any commercial arrangement – ie to exclude any right to relief in the hands of a contractor. This reflects the economic substance of where the relevant expenditure is incurred. The principal will be able to claim for that contractor’s costs if it meets the conditions in section 1053 of the CTA 2009 or, if the principal is a large company, the subcontractor may be able to claim a tax credit under the RDEC scheme.
HMRC further argued that if and to the extent that any R&D activity falls outside the ambit of the relief, this is a perfectly reasonable outcome. The legislation does not seek to ensure that all R&D activity will result in a claim for SME R&D tax relief and the legislation should not be contorted to meet that interpretation.
The Tribunal, however agreed with the submissions of the company, that the purpose of section 1052 was to act in concert with section 1053, and that together those rules prevent double claims by passing the ability to claim “up the chain” to the company that commissions and pays for the R&D activity. That was a limited and direct purpose.
The Tribunal also agreed with the company that the explanatory notes to the legislation support this interpretation. Additionally, that this interpretation was once again consistent with Quinn and also with paragraph 17 of the explanatory notes in respect of the now abolished intellectual property condition. This in effect said that the test was there to prevent others from claiming R&D if they had no right to the fruits of the R&D.
Taking all of this into account, the Judge found that HMRC’s “broad interpretation” was not appropriate.
Decision
On the subsidised expenditure condition, at paragraph 58, the judge found:
“We are not satisfied that the case [Quinn] was wrongly decided and following that decision we have also concluded that the relevant expenditure was not subsidised expenditure for the purposes of section 1138.”
On the contracted out condition, it said at [74]: “Having found that the contracts between Collins and their clients do not “contract out” R&D activities to be carried out on behalf of the Client, we have concluded that the expenditure was not incurred by Collins in carrying on activities which are contracted out to Collins by any person, for the purposes of the relevant statutory provisions.”
Key takeaways
Quinn was resoundingly endorsed by the Judge, and the principle of “judicial comity” meant that it should be followed. HMRC has long argued that Quinn is not binding precedent, yet has not accepted that it is persuasive to the extent that it should be followed by other FTTs. They now have two cases that any future FTT should follow, especially where the contract is in line with the fact pattern set out at [24(10)].
The FTTs now have one case to follow in respect of contracted out expenditure. It remains to be seen what the result in Stage One Creative Services Ltd v HMRC (heard in November 2023) will be though.
Equally, it remains to be seen whether HMRC will appeal this decision. If it does in respect of subsidised expenditure, it begs the question why it did not appeal Quinn. Much time will have been wasted if they do, and one thing more than most that companies claiming R&D want is certainty. The decision to rewrite its CIRD guidance following Quinn and the unwillingness to give the detailed judgment in that case any weight, appear to have been errors of judgment (regardless of what happens in Stage One Creative Services).
Final word
A number of cases are stayed behind this one. HMRC should quickly decide whether it will appeal and, if not, swiftly settle those cases in line with this judgment. In practice, it seems likely that HMRC will wait to see the outcome of Stage One Creative Services*, before making any final decisions.
If HMRC do concede the point, two potentially complicated questions arise. First, would HMRC take a fact-specific approach to conceding cases and, if so, where is the line likely to be drawn in any given fact pattern? Secondly, would there be any redress for companies who, at HMRC’s insistence, have previously removed a claim or changed it to be under RDEC?
- The judgment in Stage One Creative Services is now available. HMRC has confirmed that it will not appeal that decision or Collins and will update its guidance to reflect both judgments in 2025.
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