HMRC’s tighter approach to subsidised expenditure set to impact SMEs claiming R&D tax relief

Jenny Tragner

ForrestBrown, the UK’s largest specialist R&D tax relief consultancy, is warning SMEs that HMRC has started to challenge a number of R&D tax relief claims for customer-led R&D on the basis that this is subsidised by customers.

As a result, businesses that entered into a contract that relates to R&D either before or during a project are being urged by ForrestBrown to proactively review their R&D tax relief claim now, or their company could be at real risk of facing challenge from HMRC.

According to ForrestBrown, the types of businesses and projects that this topic could affect is broad, since the majority of commercial R&D will be customer-led. This includes any R&D undertaken to develop products or services with a specific customer in mind. Put simply, to understand whether a claim might be affected by this change, businesses need to be making use of the SME R&D tax scheme, and undertaking any customer-led R&D projects.

Talking about the changes afoot and the impact on SMEs, Jenny Tragner, director at ForrestBrown and member of HMRC’s R&D Consultative Committee, commented: “Most businesses have little or no interaction with HMRC when they file their R&D tax relief claim and as such, many won’t realise that things have changed. In general, the only businesses that will be aware of this are the small number who have so far received an HMRC enquiry. We have seen this trend in a small number of our own claims, and in those prepared elsewhere that we have supported through the enquiry process.

“However, this is due to change very soon. We are aware that HMRC is in the process of updating their published guidance on this issue. Once this new guidance is live, all companies making SME R&D tax relief claims will need to reconsider their filing position and the disclosures to HMRC required to protect their business. That’s why we’re urging any business in this situation to act now.”

To highlight what impact this could have on SMEs, ForrestBrown has provided two examples in practice – with the below considering a simple product development scenario in the manufacturing sector. While these examples deal with product development, contracts for services are affected in a similar way.

EXAMPLE 1: Developing a product

Say a company decides to start an R&D project to develop a new product.

This company has taken on a risk and carried out self-generated R&D. On completion of the project, it hopes to sell its new product to customers and retailers, but they have neither contracted this R&D to the company nor are they subsidising the company’s R&D expenditure by purchasing the product from it. SME relief should therefore be available.

EXAMPLE 2: Commission of a product

In the above example, the company instead secures a contract upfront with a retailer to supply the product once developed. Because this R&D took place to fulfil a contract, HMRC now consider this arrangement would render the underlying R&D expenditure subsidised by the retailer. In HMRC’s opinion, therefore, SME relief is not available.

Speculating on why HMRC might be adopting this new approach, Jenny continued: “We think that HMRC are implementing this new approach to subsidised expenditure in an effort to reduce error and fraud in R&D tax claims worth an estimated £311m. Whilst we actively share HMRC’s concerns about errors and fraud in such claims, we disagree with HMRC’s technical interpretation of the law regarding subsidised R&D expenditure and contracting out of R&D activities. We believe that it if it is applied broadly, not only does it render SME R&D tax relief vanishingly in narrow scope but it would also create unintended and unwanted policy outcomes.”

Jenny concluded: “We don’t believe that SME R&D tax relief was intended to apply only to truly ‘blue sky’ R&D. The relief is only available to companies and therefore is targeted at commercial R&D. Commercialisation is a given. Some SMEs will develop new products in the hope of being able to sell these profitably at some future date, but more will seek to manage their commercial risk by identifying customers earlier than that. Regrettably for SMEs, it appears that HMRC’s new approach to subsidised expenditure seeks to penalise these efforts.  This is wrong, both technically and economically.”

ForrestBrown is urging SMEs not to wait for HMRC to send an R&D eligibility letter, to open an enquiry or seek a discovery assessment. Now, more than ever, is a critical time for businesses to ensure that they are enquiry ready to ensure the best possible outcome.