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Interpretation of subcontracted out R&D expenditure

Please could someone clarify a question on subcontracted R&D expenditure. This area is covered in the HMRC manual here http://www.hmrc.gov.uk/manuals/cirdmanual/CIRD84250.htm

If a company carrying out R&D has a sole trader make up mock-ups or models, would you treat this as subcontracted R&D or the external supply of materials and services? Would the answer be different if the sole trader modified the models slightly from the orginal plans, using their expertise to improve the practical outcome from the design?

The particular question relates to an SME claim and whether or not this expense should be subject to the 65% restriction.

We would have thought this wasn't subcontracted R&D but a contract to provide services. However experts in R&D claims have questioned this interpretation.

We'd be interested to hear other opinions on how this should be treated.

Thanks.

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In my experience...

... contractors and subcontractors have a contract.  What does the contract actually say?  Does the contract actually delegate any R&D activity (ie please resolve some scientific or technological uncertainty for us or do some of our qualifying indirect activities for us)?

In my view that's how S.1133 CTA 2009 should be read, and nothing in CIRD84250 conflicts with that.

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Sub-Contracted

In order for the costs to be valid as "supply of materials" they would have to provide raw materials for the company to consume as part of their R&D project, which is not the case so the costs would not qualify.

It may be sub-contracted R&D but will depend on the contract in place.

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Eh?

Where exactly in the legislation does it say that a company claiming relief under the SME scheme has to subcontract their R&D to a company in order to qualify for the 65% relief?

SMEs can claim relief on 65% of R&D subcontracted to another person (See Ss.1053 & 1133-1136).  Large companies can't claim relief for R&D that's been subcontracted to another company, but can claim for R&D that's been subcontracted to a qualifying body, an individual, or a firm where all the members are individuals (See S.1078).

If the supply of external services is subcontracted R&D, then why do HMRC say in CIRD84250 that "A contract to provide services rather than to undertake a specific part of the activities is not subcontracted R&D"?

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Here

http://www.hmrc.gov.uk/manuals/cirdmanual/cird84250.htm

"Where one company engages another company to carry out R&D activity on the first company’s behalf in exchange for payment, with the first company having rights to the intellectual property resulting from the R&D then that is subcontracting of the R&D to the second company."

The HMRC do not class a sole trader as a company, well for R&D purposes anyway.

I've had this confirmed by two different HMRC R&D inspectors and I have seen a few claims where sole traders were included as sub-contractors and the HMRC in each case blocked them due to this.

This bit -

"A contract to provide services rather than to undertake a specific part of the activities is not subcontracted R&D"?

Is about who can claim for the R&D activity.  If a company undertaking an R&D project instructed another firm to design and develop a product for them, then that would be sub-contracted R&D and the company could claim the costs.

If however they instructed another firm to provide them with a finished item and the other firm had to undertake some R&D to provide the finished item, then they could claim for their own R&D project and the original company could not claim for the costs (unless the item was going to be used as a consumable).

There is no definition of sub-contractor in the HMRC R&D guidelines, but who can claim for work undertaken comes down to the following -

1) Who takes the financial risk

2) Who owns the IP (this used to be a requirement for any R&D project but was dropped a few years ago)

3) How muich freedom each party has in the work they do

 

 

 

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Thank you

You've confirmed what I suspected.

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No Problem

The rules regarding R&D can be a bit tricky, CCH do an excellent book which tries to expand on the HMRC guidelines for those who are interested - http://www.cch.co.uk/croner/jsp/newgroupDetails.do?bundleGroupId=1781497&channelId=-555562&Failed_Reason=No+BVCookie+present+to+retrieve+the+session.&Failed_Page=%2fjsp%2fnewgroupDetails.do&BV_UseBVCookie=No

 

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Merlyn, please clarify

s1078 quite clearly states that R&D can be contracted out to an individual. So why do you say "As Sub-Contracted R&D has to be undertaken by a Limited company, so any work done by a sole trader would not qualify." ?

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HMRC Rules

Because thats what the HMRC have told me on numerous occasions and when a client of mine put through an R&D claim with 40k of sub-contractor costs listed the Inspector refused to pay them based on the fact that sub-contracted work has to be undertaken by a limited company.

Feel free to contact your local HMRC R&D Unit though (http://www.hmrc.gov.uk/manuals/cirdmanual/CIRD80350.htm) and if they tell you otherwise please let me know and I'll query with the inspectors who have informed me wrongly.

Sorry just to add, the HMRC told me that this rule does not apply if the company is not UK based as it can't be a limited company.

 

 

 

 

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Authority

I was referring to CCH's guidance which clearly states that an SME may subcontract R&D to a company or another person. Now CCH don't have any greater statutory authority than HMRC's manuals, but  I would not accept that relief is disallowed just because "that's what HMRC have told me" - I would want them to cite the specific statutory authority for their treatment.

And I apologise for referring to s1078 - which of course deals with large scheme relief claimed by SMEs and has nothing to do with this specific point.

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Letter

I have the original letter from the HMRC which states where in the guidelines it says that only limited companies can be subcontractors, so I will provide a copy once I get into the office tomorrow.

 

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Tell HMRC to read the legislation and their manuals.

There's no requirement that the subcontractor be anything other than a 'person', a term that isn't limited to companies:

Quote:
s1133 “Sub-contractor” and “sub-contractor payment”

(1)     In this Part a “sub-contractor payment” means a payment made by a company to another person (“the sub-contractor”) in respect of research and development contracted out by the company to that person.

This is the definition that applies for the purposes of interpreting s1053 (the SME subcontractor section). 

HMRC's own guidance says nothing about the subcontractor having to be a company:

Quote:
CIRD84200 - For an SME company, qualifying expenditure includes payments made to another person subcontracted to carry out activities that are part of the company’s relevant R&D.

The quote from CIRD84250 referring to two companies is one of a list of examples, not an indication that sub-contracting can only be undertaken between companies. In fact, that page goes on to say "As part of any examination it may be useful to examine the degree of autonomy enjoyed by the person engaged."

On the original question, whether it's subcontracted R&D or whether it's the provision of services depends on - principally - whether the work involved in creating the models is aimed at actually resolving any uncertainties, as George indicated.

 

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Lesson learned....never trust the HMRC
As afairpo is an expert when it comes to R&D I withdraw my comments about subcontractors having to be limited companies and shall have words with the HMRC inspectors who told me otherwise.

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Going back to the original point

I've changed my stance slightly!

I do accept merlyn's point on the external services to an extent.

Either you're essentially buying goods from a person, but in doing so providing them a certain degree of licence to exercise their own skill and judgement.  Not subcontracted R&D.

Or you're buying the services of that person.  Where you're buying their services, then either it's expenditure on subcontracted R&D or it just isn't expenditure on R&D.  I can't actually find any middle ground now that I've reflected on it.

Pains me to admit it!

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Thanks for a lot of replies!

George Attazder wrote:

I've changed my stance slightly!

I do accept merlyn's point on the external services to an extent.

Either you're essentially buying goods from a person, but in doing so providing them a certain degree of licence to exercise their own skill and judgement.  Not subcontracted R&D.

Or you're buying the services of that person.  Where you're buying their services, then either it's expenditure on subcontracted R&D or it just isn't expenditure on R&D.  I can't actually find any middle ground now that I've reflected on it.

Pains me to admit it!

I agree with this. On looking at this further it will either be subcontract, or if the person supplies the materials it could be classed as Consumable Materials.

On another point regarding whether an individual ('a self-employed consultant') the HMRC manual says that they can be at the bottom of CIRD84100, when saying that an individual cannot be classed as an Externally Proovided Worker.

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Supply of transformable items

Not classed as sub-contracted but in this case both companies could make a claim -

Company X asks Company Y to provide them with a new kind of electronic component, that component doesn't currently exist so Company Y undertakes their own R&D project to design and develop it, all at Company Y's financial risk and with them owning all the IP of the finished product should they be successful.

Provided the project meets all the HMRC guidelines company Y would be able to claim for the project to develop the component, but also as company X is going to use the component in their prototype, then they would be able to claim the cost of the finished component at 100% as it's a transformable item.

http://www.hmrc.gov.uk/manuals/cirdmanual/CIRD82400.htm

 

 

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What I find odd ...

... is that in my many dealings with the R&D teams I have found them to be the more intelligent and knowledgeable of HMRC staff. Perhaps I've just been fortunate to deal with the 'right' people but I find it strange that an R&D Inspector would make such a fundamental error. I'd be interested still to see the text of the letter that Merlyn referred to, to see where that misunderstanding lies.

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me too
Usually their advice is very good, so I will be bringing this up.

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So ...

... can you provide the text of that letter?

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yes
Once I'm in the office I'll dig it out.

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Spoke to the inspector
And both the company and sub-contractor were located in the same building they assumed it was an EPW relationship, under which the member of staff has to be provided via a staff provider. So a limited company etc.

Now I've clarified they are going to put the costs back in for sub-contractors who are sole traders.

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Phew, nice to see that the R&D guys haven't lost their marbles!

merlyn wrote:
both the company and sub-contractor were located in the same building they assumed it was an EPW relationship, under which the member of staff has to be provided via a staff provider. So a limited company etc. Now I've clarified they are going to put the costs back in for sub-contractors who are sole traders.

Ah, that makes sense - the EPW deduction is only company to company [EDIT: no it isn't, see below. Typed too fast in relief that HMRC R&D haven't gone mad]

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Anne, please come back!

I can't see anything in Ss.1127-1132 that requires the staff provider (or even the staff controller where it's different) to be an incorporated entity.

I accept that a sole-trader can't supply himself as staff or that partners in a partnership can't supply themselves as staff, but both are capable of providing other people.

Or have I got it all wrong?

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Ack, yes
Sorry - you're right - typed too fast and I was distracted by the changes this year to allow people with personal service companies to qualify as supplied by a staff provider as EPW where all other conditions are met. The staff provider itself just needs to be a legal person, legally distinct from the staff provided.

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