Is HMRC moving the goal posts for companies claiming R&D tax relief?

Thursday, September 03, 2009 | Posted by: Grant Thornton
Categories: Business | Tags: R&D, Tax, innovation, investment, government, funding

The Grant Thornton team is aware of revised HMRC thinking in the following areas:

Production costs
Perhaps the most significant of changes relates to HMRC’s stance on costs which relate to the production of products and services for supply to customers. HMRC’s new approach appears to prohibit claims for any production costs where there is the prospect of producing goods or services to customers, even if as part of that production the company is seeking technological advancement through the resolution of technological uncertainty. This is understood to exclude claims in respect of prototypes and ‘first of classes’ that are subsequently sold for use rather than scrapped.

Many in the industry argue that this interpretation reflects a lack of understanding on HMRC’s part with regard to how commercial R&D is carried out in the UK and precludes R&D that the Department of Trade and Industry never intended to exclude in its definitions upon which the relief is based.

100% staff time claims
We have recently become aware of a more aggressive approach from HMRC on challenging claims for 100% of staff time on R&D activities. The basis of HMRC’s challenge is that no member of staff can spend all their time on R&D activities and will always have an element of administrative time in their day-to-day activities and employment relationship. Though not yet formal HMRC policy, the increased frequency with which Grant Thornton is seeing 100% claims challenged suggests a change in practice that has not been forewarned by HMRC.

In principle, Grant Thornton does not agree that minor, incidental time should be excluded when a member of staff is employed purely for R&D activities.

Intellectual property ownership
The small company scheme provides a higher level of relief than that available to large companies but is subject to meeting more stringent conditions. In particular, the claimant company must own any intellectual property (IP) generated, although the legislation allows them to hold this outright or jointly with others. Historically, this has been interpreted as a requirement to own some portion of the IP at some time. However, HMRC is now suggesting that the claimant must have rights over 100% of the IP, although these can be joint rights and that the claimant must have rights to exploit the IP without reference to the other party. Clearly this can create an issue for structuring IP ownership within groups.

Although the above areas represent the most significant changes to HMRC practice, we are seeing several other situations reflecting a general change in attitude towards claims. These have included the denial of relief where a trade has been hived up from a company which then became dormant on the grounds that it was not a going concern (even though the trade continued in the new company). Other situations in which we have seen challenges by HMRC include claims by subcontractors for the necessary testing of the products of R&D.

With increasing concern over the severity of the downturn, these changes in interpretation, retrospectively applied come at a time when companies making long-term investment decisions need clarity and certainty over the tax reliefs that they may or may not be entitled to. Clamping down in this area goes directly against the original purpose of the reliefs which was to stimulate R&D activity in the UK. While the UK’s income from other sectors such as financial services has declined, measures like this which reduce the effect of the fiscal stimulus in other important sectors seem very short sighted.