Important recent FTT ruling for SME R&D tax claimants

FTT rules taxpayer can claim SME R&D tax relief where R&D required to deliver products / services it has already contracted to deliver to customers.

FTT rules taxpayer can claim SME R&D tax relief where R&D required to deliver products....

This First-tier Tribunal (FTT) case, Quinn (London) Limited v HMRC, addressed one of the specific conditions required to be met for the more generous small or medium-sized enterprise (SME) research and development (R&D) tax relief. The condition is that the R&D expenditure should not be subsidised by another party. The relevant legislation is Section 1138 (1) (c) CTA 2009. This is a very important case for SMEs who contract with clients to deliver products and services, and R&D is required to be undertaken to deliver the products and services.

The FTT found in favour of the taxpayer, Quinn, a construction company that delivers construction services to its customers. This will be welcome news to many SMEs who contract with clients to deliver products or services where R&D is required to produce them.

HMRC argued that where a taxpayer contracts with a client before or at the time of the R&D activity then the R&D is being subsidised indirectly by the client. Under the HMRC interpretation, an SME that performs R&D to produce a product in January, then contracts with a customer to sell the product arising from that R&D in April may claim the SME tax relief. Whereas an SME that contracts with a customer in January to sell a product and then undertakes R&D to develop the product it has contracted to sell cannot claim under the SME relief as the R&D expenditure has been directly or indirectly met by the customer.

The taxpayer argued that the payments received are a commercial return for the product itself and do not amount to a subsidy that directly or indirectly meets the R&D expenditure. Regardless of how the price is measured, the taxpayer successfully argued that the payments are for the value of the products or services exchanged for a commercial price.

The FTT ruling found in favour of the taxpayer’s arguments and agreed that in order for expenditure to have been met, the third party (the customer in this case) must either directly meet the payment to the creditor or indirectly reimburse the taxpayer, and the payments must have a clear and direct link to the R&D expenditure.

This case at face value appears to be a very different outcome to the recent FTT case Hadee Engineering Co v HMRC that HMRC won and involved the same statutory condition for SME relief. However, Hadee can be distinguished as what limited evidence was produced by the taxpayer in that case suggested there was a direct link between design hours and the amounts paid by the customer and therefore it did amount to subsidised expenditure. It was noted by the Tribunal Judge in Quinn that Hadee was of limited value due to the absence of clear evidence of what contractual arrangements existed and because legal precedent of similarly worded legislation in different areas of tax was not cited to the Tribunal in that case.

In conclusion, whilst the FTT judgment does not set legal precedent it does provide some clear and persuasive logic to how the subsidised condition should apply and will be very welcomed by many SMEs. . Unfortunately, there was no consideration of the contracted out provisions for SMEs that were addressed in Hadee, which would also benefit from a more detailed case for judgment. This decision is an important one for SMEs that perform R&D to deliver commercial products and services that have been contracted for at the time of the R&D activity.