One of the key areas of change in the Merged R&D scheme and R&D intensive SME scheme relates to subcontracted, or “contracted out” R&D – to use HMRC’s own phrase.
Even if subcontracting doesn’t come up in your work very often, you’ll want to know what to do in the event that it does.
Who can claim for subcontracted R&D activities?
The right to make an R&D claim sits with the customer, if they can show that the R&D activities have been contracted out and they can show that they intended the R&D activities to be part of the contract.
HMRC clarified what exactly is meant by “contracted out R&D” in CIRD161000.
Basically, first dibs on making an R&D claim depends on which party intended or contemplated that R&D was required. A lot of emphasis is put on what “intended” or “contemplated” means. The guidance relays that it’s more than a simple awareness that R&D might be required. The meaning extends to a more detailed understanding of the desired advance and what uncertainties need to be resolved.
If you’re the customer, the major difference compared to the previous view of contracted-out R&D activities lies in the amount of evidence needed. You’ll need to provide evidence that the R&D was “intended” or “contemplated” at the time that the contract was entered into. HMRC is clear that this is a hard line. The evidence must be exhaustive, and it must be dated before a contract was entered into or at the point the contract was drafted. Without it, it’s very likely that the claim will be denied.
From the contractor’s perspective, the considerations are a bit different. The crucial point you need to consider is whether R&D was “intended” or “contemplated” in the agreement with the customer.
An example of how subcontracting works under the new merged R&D scheme
Let’s consider an example: Company A is under contract to build a bespoke piece of machinery for company B, and in the process Company A undertakes R&D activities.
It’s most likely, in this scenario, that Company A would recognise and complete R&D activities after the project has begun. In this case, Company A is able to submit a claim for R&D tax relief, even if the R&D activities were necessary to meet the requirements of the contract. The exception is if there’s evidence that Company B is intending or contemplating that Company A will undertake the R&D activities to complete the project – in that case, Company B would be eligible to claim.
HMRC has included a number of examples in the guidance to help explain how to apply the rules in practice.
If you’re looking for another way to visualise the rules, this is one of the topics covered in the course An Advisor’s Essential Guide to the Merged R&D Scheme.
How can you apply these subcontracting rules in practice?
When considering whether your client has a valid R&D claim, you need to rely on the evidence in contracts and other communication. If R&D activity is described at or before the contract stage and qualifies as R&D for tax purposes, you can assume the claim lies with the customer. But, if this evidence is absent, it’s a good indicator that the contractor has the right to make the claim.
We’ll be releasing a course on Contracted Out R&D in the next few months, as part of the material for our upcoming Advanced Certification in R&D tax relief. If you’re interested in that training, make sure you’re on our mailing list so you’ll hear when it’s released.
