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A recent tribunal case has highlighted several issues around HMRC’s definition of subsidised expenditure.

While the case involving construction firm Quinn London Limited and HMRC is now closed, its outcome leaves questions for many businesses seeking R&D tax relief regardless of whether they already have specialist advisory support of the kind offered by Kene Partners.

Here, we discuss the case and look at the possible ramifications for future client-led R&D projects.

Quinn London vs HMRC: What happened?

Quinn London, a building contractor, claimed enhanced R&D tax relief for several projects where its development demonstrated an overall advance in technological knowledge and/or capabilities.

As part of the SME tax relief process, claimants must be able to demonstrate that the costs of their R&D projects have not been subsidised – meaning covered, directly or indirectly and in part or in full, by a third party.

HMRC rejected Quinn’s claim, ruling the company had failed to fulfil this condition.

It argued that payments made by Quinn’s clients for its finished building works were, in themselves, sufficient evidence of the R&D expenditure in question having been subsidized.

Quinn successfully appealed to the First-Tier Tribunal (FTT), which ruled the company was entitled to tax relief totalling approximately £1 million.

Ruling against HMRC’s reasoning, Tribunal Judge Harriet Morgan stated that a project could only be considered subsidised if there was a “clear link” between customer payments and R&D expenditure.

She explained: “… it would be wholly out of kilter with the overall SME scheme, if an SME were to be denied enhanced R&D relief solely because, in doing what is envisaged by the legislation (namely, utilising the relevant R&D for the purposes of its trade), it seeks to recover some or all of the relevant costs of the R&D under its commercial contracts with its clients entered into in the course of its ordinary trading activities.

“Indeed, if HMRC’s approach were to be adopted, the circumstances in which an SME could claim enhanced R&D relief would seem to be confined to those where it has no prospect of exploiting the R&D for commercial gain.”

Why is this case so significant?

This case matters to businesses claiming R&D relief for several reasons.

HMRC traditionally defined subsidy as being any money provided by an external third party to the business which is spent on R&D work. This was often linked to grant funding.

Over the last few years, though, HMRC has broadened the scope of what it considers subsidised expenditure and, perhaps in the interest of combating errors and fraudulent claims, have begun to contest that any paid work for clients could be considered ‘subsidised’ and may therefore not be eligible for R&D tax relief.

If applied to claimants throughout the UK, HMRC’s revised definition would mean that any business that charges for or plans to sell work comprising R&D would become ineligible – along with any company using third parties as part of its research and development.

For the most part, the outcome of Quinn’s appeal will have reassured thousands of businesses who inherit a financial risk when problem-solving and taking on R&D projects on behalf of clients; not just those in the construction sector.

The ruling has provided a conclusion of sorts, and will no doubt ease some speculation. Though it’s still no guarantee of a smooth R&D incentive process for small businesses: HMRC have stated that they will continue to open enquiries into R&D claims on the basis of subsidized expenditure.

The long and complex journey to tribunal might explain why this is the first case of its kind to go so far. We can’t assume that other SMEs, especially those applying for R&D relief without any professional support, will have the resilience, resources and confidence necessary to go through the same process as Quinn – even if they are entitled to funding. For some, the complexity and fear of enquiry might be enough of a deterrent to halt or prevent continued claims and/or investment into vital R&D projects. That goes against the purpose of R&D tax credits, which has always been to encourage innovation.

We need more clarity from HMRC

HMRC has a duty to monitor the R&D incentives, and it may yet continue to investigate client-led R&D projects. Its initial change in subsidy definition was likely aimed at clamping down on fraudulent claims, and that’s something most businesses and R&D advisers will welcome.

While the Quinn case has shown what we can expect from a judicial perspective, it doesn’t tell us where HMRC currently stands on the issue – and that uncertainty will require some redressive clarity in the coming years.

By providing further guidance, much like it did around software expenditure, HMRC could assist businesses in planning while also making its job more manageable. For the best results, this kind of guidance should be built from further consultation with the industry and with businesses seeking to claim this kind of relief.

Final word: enquiries happen

Businesses can’t avoid HMRC enquiries. What they can do is ensure their original submissions and all subsequent documentation show clearly and consistently the boundaries and ownership of all R&D work.

At Kene Partners, our approach has always been to build a robust claim with a clear methodology for HMRC at the front end of every claim. This means all our claims deliver the maximum value for our client’s investment in innovation while withstanding any scrutiny from HMRC.

For more information, watch our recent round-table discussion on the topic or get in touch with our team of expert advisers today.