Updated guidance on R&D for tax purposes

The past twelve months have been a tumultuous one for the UK’s R&D tax relief system, and the companies who claim benefits from it. It kicked off with newspaper articles noting the amount of error and fraud in the system, picking on particularly media-friendly case studies to demonstrate this. At around the same time, Jeremy Hunt announced rate changes to the R&D relief as part of the 2022 Autumn Budget. The House of Lords announced that an enquiry would begin into the generous and strategically important scheme, to work out how to combat error and fraud, as exploring any potential modernisation of the Guidelines.

In the space of two months, the R&D tax reliefs were thrust into the public eye. HMRC’s response was swift: it established a Campaigns & Projects (C&P) team to conduct R&D enquiries; and more than doubled the number of dedicated R&D tax caseworkers. In many ways, this was welcome. It was clear that compliance in R&D tax relief claims had become a major issue, and it was important to put a stop to ‘spurious claims’, as The Times described them. The manner in which these compliance checks have been conducted has, however, been far from ideal. This has been widely documented. There have been parliamentary questions and letters from industry bodies, and so HMRC have come under increased pressure to improve the quality of the C&P team and to improve ‘education’ among companies.

What is included in the new guidance?

As had been promised by Philippa Madelin, the head of HMRC’s Wealthy and Mid-Sized Business Compliance Department, new Guidelines for Compliance were published on the 31^st October. This is probably the most comprehensive fresh R&D related guidance since the CIRD Manual was first published, almost twenty years ago. It consists of roughly thirty pages of detailed information and explanation, split into six parts: ‘purpose, scope and background’; ‘expectations of claimants’; ‘importance of a competent professional’; ‘how to identify qualifying R&D activities; recommended approach to claims and record-keeping’; and some ‘further information’.

Clarifications on what qualifies for R&D tax relief

While the first and last sections are not of particular use to a company, the middle four sections are informative and helpful. In the second section, ‘expectations of claimants’, HMRC outline a 14-step approach they expect any company to take in the preparation of an R&D claim. To companies already claiming with the help of thorough advisors, nothing here should come as a surprise; it is a useful guide to see whether the preparation process you currently have is sufficient to meet HMRC’s minimum standards. The third part, meanwhile, reminds us of the importance of having people with the necessary expertise to make judgements on the current state of science and technology, and on whether something can be classed as innovative (or an ‘advance’, to use the scheme’s language).

The most interesting part of the new guidance is part four, which provides clarification on how HMRC currently interpret the R&D Guidelines. Historically, examples of how to apply the Statutory Guidelines were very rare. The Guidelines themselves had a handful of examples, but these were outdated – one discussed the production of DVD players, which is not something that many companies have done for the last fifteen years. The much more detailed HMRC R&D Manual, meanwhile, provided four examples, but all related to software technology. This guidance has 23 examples, relevant for a range of industries: software; automotive; engineering; construction; food manufacturing; goods manufacturing; electronics manufacturing; life sciences; dermatology and cosmetics; sports science; and chemical manufacturing.

Tips on record-keeping

As always with hypotheticals, these examples lack specifics. They are, however, useful in indicating how to draw the boundaries between a specifically defined R&D project and wider commercial one; what an ‘advance’ on overall knowledge can look like, including when a select few others might have achieved that advance already; and how to draw the distinction between routine work and ‘qualifying’ work. The examples can be useful for companies who are planning on claiming, but unsure exactly what qualifies; companies who are uncertain whether they are currently claiming correctly; and for companies, and their advisors, engaged in time-consuming compliance, as reference points to justify the projects under question. Across all, though, it represents a step forward in re-establishing a constructive relationship between HMRC and SMEs that claim for R&D tax relief.

Effective Record-Keeping Practices for R&D Tax Claims

A question many companies have when claiming R&D tax relief is how they should track the work they are doing, and what kind of records and evidence they should have when making a claim. A lack of documentation has been a problem for companies before, as seen in both the Hadee Engineering and AHK Recruitment first-tier tax tribunal cases, which were rejected – partly – due to a lack of evidence. HMRC have always been hesitant to prescribe what R&D-specific documents they expect to see. Their older guidance for instance, stated that ‘there is no record keeping requirement specifically for the purposes of claiming R&D relief, but the general CTSA requirement to keep sufficient records applies’. Quite vague, to be sure. This had the benefit of allowing flexibility and understanding specific differences in company size and industries, but created an unnecessary level of uncertainty.

This new guidance tackles this question directly. The result is quite comprehensive, while still giving some discretion to smaller companies and trying not to interfere too much with day-to-day business activities. Documentation which is good to justify a claim, it notes, can include project charts, drawings, designs, test logs, photos, meeting minutes, and emails. In some industries, this may be less common, especially if you only realised that the project might qualify retrospectively. In this case, HMRC’s advice continues to be quite non-prescriptive, so we think it is worth thinking about how you feel you can best justify the claim and spend time very specifically describing and explaining the projects, their uncertainties, and the advance.

If you are a company that has claimed in the past and wants to improve your record-keeping for future R&D claims, then this section of the guidance is especially relevant. If you start undertaking a project that is especially challenging and looks like it might need to go beyond current practice or knowledge in the field, then it is good practice to note it down. Alongside this, add a brief description of what you can see the state of knowledge to be, what the specific advance might need to be, and what the specific uncertainties are associated with that advance. We strongly recommend this kind of approach. If you follow it, not only will you be more protected in a compliance check, but it means that when you sit down with your R&D adviser at the end of the year the correct R&D costs can be identified much quicker, easier, and more accurately.

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