R&D tax credits – Collins Construction First-tier Tribunal decision
Decision provides insight into the application of the ‘subcontracted’ and ‘subsidised’ R&D rules for SME claimants
Decision provides insight into application of ‘subcontracted’ and ‘subsidised’ R&D rules
In the Collins Construction Ltd First-tier Tribunal (FTT) decision, HMRC have lost a case that considers the application of the ‘subcontracted’ and ‘subsidised’ research and development (R&D) conditions for the small and medium-sized enterprise (SME) R&D regime. The conditions are that if the R&D expenditure has either been subsidised or the R&D activities subcontracted to an SME claimant by a customer a claim under the SME regime is not available. In this instance a claim would instead need to be considered under the large companies R&D expenditure credit regime (RDEC).
This decision comes against a backdrop of HMRC increasingly seeking to reject SME claims where R&D activity relates to delivery of services and products under customer contracts based on a wider interpretation of the subsidised and subcontracted conditions. The FTT decision in Hadee Engineering Co Ltd is often quoted by HMRC when reaching such conclusions. The decision in Collins Construction rejected HMRC’s arguments and provides insight into the Tribunal’s views on the application of the subcontracted and subsidised R&D rules for SME claimants.
Background
Collins Construction Ltd (Collins) incurred expenditure on R&D in respect of bespoke construction projects in which it was engaged by third parties. HMRC rejected Collins’ claim for R&D relief under the SME scheme on two grounds: the expenditure was (i) ‘subsidised expenditure’; and/or (ii) had been incurred in carrying on activities which were ‘contracted out’ to Collins.
It was not in dispute that the other conditions for relief were satisfied. Collins appeal was allowed on both issues.
Collins is understood to be one of two lead cases for a number of other appeals currently before the FTT. A decision of the FTT in the other lead case, Stage One Creative, is expected shortly.
Issue 1 – Whether the expenditure was ‘subsidised expenditure’
This issue turned on whether the expenditure was ‘met directly or indirectly’ by another person within the meaning of s1138(1)(c) CTA 2009, i.e. the same issue considered by the FTT in Quinn (London) Limited.
HMRC argued (as it did in Quinn) that the payments received from third parties under the construction contracts reimbursed Collins for R&D undertaken with the consequence that expenditure was met indirectly by another person, i.e. Collins’ customer.
Collins argued that the expenditure was not subsidised as contracts with customers were to provide specified works in return for the payment of an agreed price. That price may or may not be sufficient to cover the costs Collins actually incurred in meeting the terms of the contract, including any R&D costs. The bargain with its customers was not to incur specific costs in return for the clients agreeing to pay those costs. In support of its position, Collins relied on the FTT decision in Quinn and the endorsement of that approach by the Upper Tribunal in Perenco.
As previous decisions of the FTT are not binding, the Tribunal in Collins considered the principal of ‘judicial comity’. That principal provides that, while courts like the FTT might not be bound by decisions reached by other FTT judges in other cases, conclusions reached in other cases “will be highly persuasive and should be followed unless the second court is convinced that they are wrong”.
After careful consideration of the Quinn decision, the Tribunal considered it was not wrong and went further, stating it agreed with the approach taken in Quinn. It found that the circumstances of this case (and Quinn) are far removed from those which are intended to be captured by s1138(1)(c) CTA 2009 on a fair reading in the context of the section and overall SME scheme. The Tribunal reiterated that for expenditure to be subsidised, ‘a clear link’ is needed between the price paid by the customer/client and the expenditure on R&D.
Issue 2 – Whether the expenditure had been ‘contracted out’
HMRC argued that the R&D expenditure was incurred in the performance of the construction contract. Had the contract not been in place, Collins would not have incurred the R&D expenditure.
Collins argued that in order for expenditure to be ‘contracted out’, the R&D activities would have to have been required by the terms of the contract or be within the parties’ reasonable contemplation at the time the contract was entered into. Collins argued that there were no terms within the contract to require Collins to undertake R&D activities, nor were R&D activities within the parties’ contemplation at the time the contract was made.
The Tribunal found that under the contracts and working arrangements, Collins did not agree to carry out the R&D activities for payment and Collins’ customers did not agree to reimburse the expenditure incurred on R&D activities. As a result, the expenditure was not incurred in respect of activities which were contracted out to Collins.
The Tribunal also helpfully explored the purpose of the ‘contracted out’ provision, indicating that the purpose and function of the condition was to operate in concert with the provisions that prevent double relief from being granted for the same R&D.
Implications of this FTT decision
Both the ‘subsidised expenditure’ and ‘contracted out’ issues are regularly raised by HMRC in enquiries. We have been aware for some time that HMRC disagree with the decision in Quinn and HMRC have regularly adopted the positions which it unsuccessfully tried to take in Collins on both of these issues. This decision may cause HMRC to re-think their approach to these issues in ongoing and future enquiries but the issues do ultimately turn on the correct interpretation of the law and may be appealed by HMRC, particularly given the case is one of two lead cases, such that the decision will be relevant to a broader number of appeals.
The Collins case does, however, serve to strengthen the position of claimant companies which have adopted a similar position to Collins and are currently under enquiry in respect of either ‘subsidised’ or ‘contracted out’ expenditure. Claimants would be well advised to consider the Collins and Quinn decisions in any further rounds of communication with HMRC.
Considerations for future claims
The recently merged RDEC regime and SME intensive regime bring in a new set of subcontracted R&D conditions that need to be considered for accounting periods beginning on or after 1 April 2024. Under the new regimes, tax relief is weighted in favour of the company which initiates the R&D and bears any associated risk. Broadly, therefore, any company which has R&D subcontracted to it by another UK entity will not be able to claim tax relief. Conversely, where a company subcontracts R&D out to a UK based third party, the company subcontracting the work out will be able to claim the tax relief.
The Collins decision considers the subcontracted R&D conditions for SME claimants prior to the introduction of new conditions under the merged regime. However, the approach taken by the Tribunal in Collins in interpreting and applying the legislative provisions to contractual terms and practical working arrangements will still be useful when considering the new conditions. The introduction of the new subcontracted conditions is likely to be significant for a number of claimants. If you have not yet considered the implications, KPMG can assist you in assessing your current contractual and working arrangements to determine the impact of the new subcontracted conditions and advise on any changes that can be made to reduce the risk of future claims being challenged.
