Much of the confusion stemmed from instances where subcontractors elected to carry out R&D activities for work under a contract which made no mention of R&D. In some cases, neither company involved in a project was allowed to claim, even when the work met the definition for relief.
Fortunately, this is one of the key areas of change in the Merged R&D scheme and R&D intensive SME scheme. These schemes apply to claims for accounting periods beginning on or after 1 April 2024, and they allow a subcontractor to make a claim for R&D activities if certain conditions are met.
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. Luckily, things are simpler than before. You’ll want to make yourself familiar with HMRC’s legislation, but here’s a short guide to get you caught up.
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 recent supporting guidance. It describes how the new rules apply across both the Merged scheme and R&D Intensive Scheme
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 the example of a contract for the construction of a bespoke piece of machinery.
It’s unlikely that this would amount to contracting-out of R&D activities unless there’s evidence that the customer is aware of R&D activities that are necessary to complete the project. A more likely scenario is that the contractor would recognise and complete R&D activities after the project has begun. In this case, the contractor 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.
So, things are a bit more cut-and-dry than before. There is one more complexity you need to consider, though. This involves instances where a customer requests a contractor to do some routine work, but doesn’t disclose in the contract that it forms part of a wider R&D project. The customer could include the cost of the payment to the contractor in its R&D claim if they can evidence that it was required as part of the wider R&D project. But, the contractor also has justification for submitting a claim. That is, if they feel that R&D unintended by the customer was required to fulfil the contract.
It’s unclear how costs incurred by the contractor for R&D activities could be separated from the payment made by the customer for routine activities forming part of a wider R&D project. This is a situation where a bit more practical guidance from HMRC would be appreciated, but we need to work with what we have.
If you’re looking for another way to visualise the rules, this is one of the topics we’ve covered in our new free course “An Advisor’s Essential Guide to the Merged R&D Scheme.”
How can you apply these subcontracting rules in practice?
When considering whether the customer or contractor has a valid R&D claim, you might need a bit more structure in your processes to meet the new criteria. A good rule of thumb relies on the evidence of the R&D activities. If it’s present at or before the contract stage and supports 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.
Until the new schemes are fully introduced, it’s difficult to say how these rules will work in practice. They’re likely to be a subject of considerable debate, and you’ll want to make sure that you have a good handle on them before going toe-to-toe with HMRC in a compliance check.
Our new free course can help you get to grips quickly with the changes – An Advisor’s Essential Guide to the Merged R&D Scheme.