In this article, we discuss the First Tier Tribunal (FTT) decision on Research and Development (R&D) claims for Collins Construction Ltd v HMRC. It is part of a series of recent FTT rulings on R&D addressing the conditions for determining whether expenditure is contracted out or subsidised and whether it is eligible to claim relief on.
Collins Construction (hereafter the Company) is known for their commercial refurbishment and fit out schemes. The Company engaged in projects which included developing client concept ideas to create bespoke construction projects within the commercial office, healthcare, education and leisure sectors. The Company also undertook R&D to overcome technical challenges encountered in executing some of these projects. In 2020 an enquiry was opened into the 2018 and 2019 R&D tax relief claims for the SME scheme submitted by the Company with HMRC rejecting these claims on two bases.
- Firstly, the R&D was subsidised by a third party and therefore ineligible for any R&D tax relief.
- Secondly, the R&D was contracted out to the Company by their clients, meaning they did not own the R&D and could not make a claim for it.
premise
The Company claimed for R&D projects that were deemed by HMRC to be carried out in the course of wider commercial construction projects that were paid for by customers. HMRC’s viewpoint was that the expenditure the Company was claiming was subsidised by a third party, and so ineligible for R&D tax relief, as well as the projects being carried out to meet a contract. Inferring that the projects did not ‘belong’ with the Company, but rather with the third party contracting them, and consequently the R&D was contracted out to the Company and not claimable by them.
considerations in the case
In making their decision, the First Tier Tribunal assessed the subsidised and contracted out conditions separately.
subsidised expenditure
According to the legislation, expenditure is considered subsidised either through a grant or when it is:
“otherwise met directly or indirectly by a person other than the Company”.
The Company submitted that, they were not paid based on their time or for the resources spent, but rather for completing the works, with some of the contracts completed at a loss. As the amounts paid were for the completion of the work, rather than the costs of the work, the Company asserted that the expenditure was not subsidised. This was also because the amounts paid may or may not have covered the full costs of the work.
Whilst the Company was not paid directly to carry out the R&D projects, the main issue was whether in carrying out the projects to achieve a wider commercial construction project, the payments for the wider project would mean that the R&D work would be subsidised indirectly by these payments.
The facts of this case (i.e., R&D arising during a wider construction project that is subsidised for a fixed price, that doesn’t relate to any specific development costs) were very similar to HMRC vs Quinn (London) Ltd, an earlier First Tier Tribunal case that found in favour of the appellant.
contracted out activities
According to the legislation, this occurs when expenditure is:
“incurred by the company in carrying on activities which are contracted out to the company by any person”.
HMRC argued that for the Company to meet its obligations under the contracts, it needed to incur expenditure that would fall under the definition of R&D expenditure within an R&D project.
In contrast, the Company argued that the R&D projects were not contracted out by the contract for the wider commercial works, as these R&D activities were not included within the terms of the contracts. The Company provided evidence of their contracts which were one of four types of standard contracts, namely, JCT Design and Build 2011, 2016, JCT Standard Building Contract 2011 and JCT Standard Building Contract 2016. These contracts are standard in the construction industry and were used for both R&D and non-R&D projects alike. These contracts are used for clients hiring a construction company to undertake fit-out jobs, as they themselves are not competent in the work. Clients themselves lacked the technical knowledge to identify the need for R&D to address the resulting technical challenges.
the outcome
subsidised expenditure
The tribunal agreed that the facts of the case were very similar to Quinn, and so adopted the same approach. In Quinn, the judge concluded that the contracts between Quinn and its clients was not for Quinn to incur expenditure which would be repaid by the client. And within the contexts of the SME scheme, there needed to be a clear link between client payments and expenditure on R&D for the expenditure to be subsidised. The judges found it fair to follow the decision in Quinn as they agreed with the reasoning and did not consider it to have been wrongly decided.
The tribunal rejected HMRC’s argument concluding that for expenditure to be considered ‘subsidised’ there needs to be a clear link between the funding and the use of the funds. As the payments made to the Company were not ‘linked’ to any R&D activity, the tribunal found that these payments were not ‘met directly or indirectly’ so were not subsidised. HMRC lost on this point as the tribunals’ ruling upheld the decision in Quinn.
contracted out activities
In making their decision, the tribunal assessed the rights and obligations of the Company and clients based on the contracts. They found that the contracts between the Company and its clients were for the Company to provide specified works for an agreed price subject to detailed terms and conditions set out in the contract. The agreed price may or may not cover the actual costs incurred in fulfilling the terms of the contract and, the Company and its clients agree that the Company has ownership rights to any outcomes of the R&D.
The tribunal concluded it was clear that the contracts were not for the Company to undertake R&D on behalf of their clients. They concluded that the contracts plainly showed there was no expectation of the Company to carry out R&D and be paid for it or be paid or reimbursed for any R&D it undertook.
The tribunal also considered the explanatory notes to the legislation as well as the explanatory notes relating to the now abolished IP (Intellectual Property) condition. The goal of these were to give the owner of the R&D the right to claim the tax relief. As the Company had the rights to the R&D which they could freely use in any of their work, it was more in line with the purpose of the legislation and the overall SME scheme that they could claim for the R&D.
As it was found that the expenditure was not subsidised, and the work undertaken was not contracted out by a third party, the Company was successful in their appeal with HMRC losing on both the subsidised and contracted out points.
case takeaway
This case represents a major win for companies claiming R&D tax relief, as it emphasises that this very common arrangement for R&D should not be excluded from relief. As a significant number of projects particularly in the construction industry are subsidised through similar arrangements, the tribunal has effectively avoided closing the door on relief for such projects, which will shape HMRC’s approach to claims of this kind.
It is important to note that HMRC’s approach to deny enhanced relief for companies claiming under the SME scheme, who use R&D for the purposes of their trade and recover some or all of the costs for doing so is out of touch with the essence of the legislation. It is clear that the use of R&D as part of normal trade is expected by the legislation and also those interpreting it, and HMRC’s approach would only provide relief where the R&D could not be used for the purposes of the trade.
Finally, companies need to be mindful of the effects that a contract, and the wider context of any subsidised expenditure or contracts for work undertaken can have on qualification for R&D tax relief. Companies contemplating that R&D may be required in contracted out work should carefully assess the implications of such contracts, as any missteps will lead to the expenditure being disallowed.
If you need any advice or have any questions regarding how this might affect your R&D tax relief claim, please feel free to contact rdtax@ct.me
