09Sep
At Empirical Tax, we’ve recently encountered several instances where companies are aware of the R&D Merged scheme but are unfamiliar with the rules regarding contracting out R&D activities. This lack of awareness could potentially lead to missed opportunities or compliance issues with HMRC’s updated guidelines.
While the contracted-out R&D rule has mainly been a consideration for SMEs, it’s now becoming increasingly relevant for larger companies as well. As new rules come into play, particularly with the introduction of the R&D expenditure credit and enhanced support for loss-making R&D-intensive, businesses of all sizes must pay close attention to these changes.
HMRC’s Perspective on Contracted-Out R&D
HMRC believes that placing the right to claim R&D tax relief with the company making the decisions about R&D will encourage businesses to undertake more research and development. This new approach effectively gives the company deciding to carry out the R&D the right to claim.
Where R&D is contracted out, the new R&D expenditure credit and the enhanced relief for loss-making SMEs allow the customer to claim tax relief for the contracted-out R&D—unless certain exceptions apply.
R&D is considered to be contracted out if it's reasonable to assume that the customer anticipated or planned for this type of R&D to occur. This could relate to an entire commercial project, an entire R&D project, or specific aspects of an R&D project. Importantly, the rules apply equally in all these situations. However, ‘contemplated’ in this context doesn’t mean a fleeting or minor thought; it suggests a more concrete and substantial intention.
Simplifying the Rules
To put it simply, if your company is carrying out R&D to deliver a product or service to a customer, this shouldn’t impact your ability to claim R&D tax relief—unless the customer has specifically defined the R&D activities that need to be undertaken as part of the commercial contract.
Here’s a helpful example from HMRC’s guidance that demonstrates a common scenario in the manufacturing industry:
"A manufacturer (Company A) contracts a third party (Company B) to provide specialist tooling and knows that R&D is likely to be required to develop this. The contract however is just for the provision of the prototype tooling.
These products form part of a wider R&D project of Company A. Although Company A understands that R&D is required and provides a detailed specification of product requirements, it does not possess the specialist expertise in this specific area of engineering.
Company B retains significant financial risk associated with the contract as it is undertaken at a loss (in the hope that Company A’s R&D project progresses through to manufacturing, which would ultimately result in large orders being made to Company B).
Although Company A understands that R&D will be required by Company B to fulfil the contract, Company B undertakes the associated economic risk. Furthermore, Company A does not specify for Company B, or set out internally, the R&D required (it is unable to as it lacks the expertise in this area) Company B would therefore (assuming it meets all other conditions) be in a position to claim the R&D relief."
Stay Ahead of the Changes
With the growing complexity of R&D tax submissions and new legislation, it’s more important than ever to fully understand these rules before embarking on new projects. At Empirical Tax, we work closely with our clients in real time, offering tailored advice and assessing cases to ensure they have the appropriate documentation ready in the event of an HMRC inquiry.
If you’re planning an R&D project or need clarification on how these rules apply to your business, our expert team is here to help you navigate the process and ensure you're maximising your eligible claims. Contact us today to find out more about how we can assist with your R&D tax relief needs.
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