On 13 January 2023, HMRC published a consultation seeking views on the design of a single, simplified R&D tax relief scheme, merging the existing research and development expenditure credit (RDEC) and the SME R&D relief. Leyton responded to this publication, as it has done for previous consultations. On 19 July 2023, Leyton received a further request to participate in the technical consultation process regarding the related draft legislation to ensure that the draft legislation works as intended. Our initial observation is that the draft legislation does not achieve the government’s stated aim of simplifying the regime under one set of rules – rather, it is our view that in their current draft these changes will add further complexity.
The current consultation is technical in nature. However, clear and fair guidance is needed before we can have clarity on HMRC’s intentions. Therefore, we have first set out our comments on relevant HMRC guidance.
HMRC guidance
Due to the broad and encompassing nature of existing R&D legislation, there has been the need for substantial guidance from HMRC regarding the practical application of the rules. We are grateful for HMRC’s efforts to produce detailed guidance. We understand why the R&D legislation is drafted in a broad way, but this does imply reliance on the guidance.
Subcontracting has become a point of contention under the SME scheme for the reasons set out below. Therefore, we would indeed welcome a unified and fair merged scheme. A unified scheme can truly be a move in the right direction, but SMEs should still be allowed to claim full subcontracted expenditure. Unfortunately, the current draft legislation indicates that there will continue to be contention around subcontracted expenditure.
We refer to HMRC’s recent changes to their guidance regarding subcontracting for SMEs. As at 20 April 2021, the guidance stated: “A contract to provide services rather than to undertake a specific part of the activities is not subcontracted R&D”. HMRC has since clarified this guidance and changed the wording to now read “Any activities carried out in order to fulfil the terms of a contract are considered to have been contracted to the company [i.e. non-qualifying subcontracted R&D]”. However, legal counsel, advisors and professional bodies disagree with HMRC’s view in this regard. The R&D work is not contracted to the company simply because these activities were carried out to fulfil the terms of a contract. Following previous successful litigation on this point, many taxpayers are now preparing to litigate to recover the related R&D tax credits denied by HMRC.
Draft legislation
“1042C Qualifying expenditure: general
(2) Condition A is that the activities in the course of which the expenditure is incurred are not contracted out to the company by another person in the course of a chargeable trade carried on by that person.”
There is a legal point as to whether a contract is for activities or for a product. We are therefore surprised by the use of this ‘activities’ wording given the context described above. We have suggested that HMRC should implement tighter wording and/or clearer guidance. Businesses may wish to consider their contracts and seek advice where significant R&D is involved.
HMRC are expected to announce whether they will move to a single merged scheme in the Autumn Statement, with the legislation coming into effect 1 April 2024. Please contact us if you have any questions.
