A new merged R&D scheme has been introduced to simplify R&D tax credits. But for businesses that utilise contractors, the new rules around who’s entitled to make a claim are confusing. We’ll clarify who can claim and explain how to prepare for the new scheme.

In the Autumn Statement 2023, the Chancellor announced that the SME and large companies schemes for R&D tax credits would be merging into a single simplified legislation. This single scheme will be based on the above the line RDEC legislation with some modifications to enable companies subcontracting R&D to now claim for this expenditure. Overall, we think that removing the complications around subsidised expenditure and changing benefit rates for loss making businesses is a step in the right direction.

However, there are new complications with the proposed scheme that some innovative companies need to be aware of. In what seems like a major change in policy, HMRC has altered the new scheme to reward the company paying for the R&D. This means where a company is subcontracted to undertake R&D, it might be excluded from claiming.

Subcontracted R&D

Under the old RDEC scheme, large companies could not claim for R&D contracted out to another third party. This caused issues when this subcontracted work was routine, such as cleaning test tubes in a laboratory, for example, which was critical to the R&D project. Under the old rules, no one could claim for this eligible work. When the scheme was first proposed, it highlighted that this anomaly would be reviewed at a later date to see if it was having a detrimental effect.

HMRC’s position as stated in the Autumn Statement is as follows:

“The objective of the R&D reliefs is to increase the overall levels of R&D in the UK economy to generate productivity growth by reducing the cost of investing in R&D, counteracting the market failure from the risk that arises from investing in R&D. Therefore, it’s important that the company making the decision to do the R&D and bearing the risk gets the relief. Allowing the decision maker to claim for R&D contracted out aligns the relief better with the company that holds the risk.

For these reasons, in the draft legislation published in July, the government proposed adopting a position on subcontracting where the decision maker is allowed to claim for contracted out R&D.”

This change will benefit large companies at the expense of SMEs who typically form the bulk of subcontractors within a larger R&D project. Therefore, under the new scheme these contractors are excluded from making a claim. In our opinion, the group of companies worst impacted by this change are likely to be architects, engineering consultants, and technical consultants who are brought in to provide specialist skills on a project.

Who can make an R&D claim?

HMRC has realised in certain circumstances the work might be subcontracted but the R&D is initiated by the subcontractor. For example, a developer is looking for a certain building size and look but the architect has to undertake R&D on an aspect of the cladding design to make this work with the adjoining buildings. Potentially in this case, the architect could claim. Or in HMRC’s own words:

“Where a company with a valid R&D project contracts a third party to undertake some of the (qualifying) work connected with their R&D project, the company may claim the relevant (qualifying) costs. The company contracted to do that work may not claim for R&D activities which delivers the project outcome for another company’s project.

If a company is contracted to do work for another company, but the work does not form part of R&D for the customer and was initiated by the contractor, then the contractor may be able to claim relief for their work, if they meet the requirements of having valid R&D which is otherwise eligible for tax relief.”

However, the wording in the draft legislation is very brief and open to interpretation:

A company being subcontracted can still claim when: “it’s reasonable to assume, having regard to the terms of the contract and circumstances, that the person intended when entering into the contract that research and development of that sort would be undertaken in order to meet those obligations.”

This obviously points towards some major problems. Potentially the two parties involved in the contract may not agree who initiated the R&D, and it’s unlikely that any documentation will be in existence that can break this deadlock. Or what happens in the case where a structural engineer knows the building has a river running a culvert beneath it, and there ends up being a major R&D project to overcome the structural weakness of the surrounding ground due to waterlogging? The river path is known, and it’s known that potentially this could cause an issue. Is this R&D work part of the activities that would be reasonably assumed would take place on the project?

Will HMRC take the word of a subcontractor that they initiated the work, or will we retain an uncertain application of the rule similar to the current subsided expenditure problems that are moving toward tribunal to finally decided what the legislation says? For consulting businesses, the new scheme is clearly more complex and potentially a lost cause if HMRC interpret the rules too rigidly.

If the default position becomes that where work is associated with a contract it must have been initiated by the contractor, many innovative businesses which employ highly trained and talented staff will be locked out of the R&D credits scheme altogether. This would seem to be the wrong conclusion and a major oversight to retaining talented, highly qualified staff in the UK.

Next steps

Our key points to consider are:

1. Review your current R&D claim and identify projects that might be at risk under the new scheme. This will allow your business to plan accordingly. We can help with assessing your current projects against the new rules to assist with this process.

2. Do your contracting arrangements need to clearly state who has initiated the R&D and therefore define which party can make an R&D claim?

3. If your business is restricted from making a claim, can you turn this loss into a win and add R&D claim support to your contracts? Many claimants will need the input of the technical specialists to prepare documentation to support their claim. Could your technical staff offer this support as a paid exercise?

4. If your business is unable to gain benefit from the R&D claim, then this might offer the opportunity to expand your scope of services and recoup some of the lost benefit through assisting contractors with their claim preparation process. But don’t leave this discussion until the last minute as it may well be too late to sort out lack of documentation or you may find that the contractor has already claimed, and you are locked out of the scheme altogether.