HMRC has changed its guidance on R&D for subcontractors – and the implications are huge

23rd Jun 2022
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HMRC's rules about R&D claims and subcontractors have always been confusing. Recent changes aren't making things any easier.

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If you keep close tabs on what’s going on in the R&D consultancy world, you’ll know that advisors are struggling to understand and adjust to HMRC’s new guidance on subcontracted R&D. Or more specifically, what happens when your client is carrying out R&D while acting as a subcontractor.

To explain how big HMRC’s changes are, and why they’re causing such a stir, we first need to explain what the status quo was. Deciding whether an R&D claim sits with the subcontractor or the company commissioning the work hasn’t been as clear cut as you’d think.

HMRC’s old guidance covered the case where ‘R&D activities’ had been contracted out. If SME A contracted R&D activities to SME B, then SME A was able to claim 65% of the payment made to SME B. SME B could not claim. All very clear.

A diagram showing that SME A is allowed to claim for 65% of the cost of a contract with SME B, where that contract was for R&D activities
The R&D Community
What was much less clear, however, was what should happen when contracts did not specify that R&D activities should be carried out. Contracts that specified what should be delivered, rather than how

Given this gap in the guidance, common practice in the R&D industry was to base a claim based on factors like whether the company in question employed people with the skills and experience required to make the advance (i.e. Competent Professionals), and whether they were working independently, taking the technical and financial risk, and creating new IP. Normally, a strong argument could be made for the claim sitting with the subcontractor.

Related: 3 steps to effective eligibility screening conversations 

A diagram showing that SME B is allowed submit a claim for R&D on a project contracted by SME A, as long as the contract was NOT for R&D activities, and if SME B meets other eligibility criteria.
The R&D Community

This approach was supported by both the Quinn (London) and Hadee Engineering Tribunals. Both companies were deemed to be undertaking R&D under the SME scheme despite acting as a subcontractor.

Why have HMRC changed the guidance on subcontracting?

The big problem with this approach was ‘double-dipping’, in which both companies made R&D claims for the same work.

HMRC’s recent changes have made double-dipping much harder. The guidance now says that any activities contracted to SME B cannot be qualifying expenditure. It also says that any activities carried out by SME B to fulfil the contract cannot be claimed by SME B.

By broadening the guidance in this way, HMRC is slamming the door on claims from companies conducting R&D while acting as a subcontractor (as has been common).

The impact of this is potentially huge. If HMRC’s new approach is successful, large numbers of highly skilled technical companies will be prevented from claiming. Even worse, large numbers of ‘SME As’ may be led to think they can claim for R&D relief just because they’ve paid a subcontractor to complete a task – irrespective of whether R&D was involved. (‘Well, if the subcontractor can’t claim, we must be able to, right?’).

I say ‘if’ HMRC is successful because it’s far from certain that they will be. Previous R&D Tribunals upheld the principle that a company can claim SME R&D tax relief while acting as a subcontractor, so it seems highly likely that more Tribunals will follow – and go in the company’s favour.

What changes are coming next from HMRC?

HMRC have told us they’re planning more consultations and changes to the guidance over the next 12 months. In The R&D Community, we offer our members regular webinars and new training courses to keep them up to date with HMRC’s guidance and how to interpret it. You can find out more about our training if you’re interested in joining us.

If you’re not yet ready to join, you can sign up to our mailing list to get regular updates from us. We’ll highlight whenever there are key changes to the guidance, and we’ll give you the details of new courses and webinars as they come out.