Any company engaging in R&D activities and claiming tax relief will have claimed in one, if not many, eligible cost categories. Naturally, each category has a set of requirements and it’s important to know what these are. For a number of categories ‘incurred costs’ and ‘paid costs’ are not the same things. In simple terms, some costs require expenses to be paid before they can be included in the claim, namely:
- staffing costs,
- externally provided workers,
- sub-contracted R&D (SME scheme),
- payments to clinical trial subjects,
- contributions to independent R&D (large companies).
Gas Recovery and Recycle Limited (GRRL) discovered this the hard way…
…in a 2016 court case: Gas Recovery And Recycle Limited v The Commissioners For Her Majesty’s Revenue & Customs  UKFTT 746 (TC).
GRRL hired sub-contractors, Microgas Systems Limited (MSL), to undertake certain R&D activities on its behalf. For the year ending March 2013, the company was due to pay them £1,112,434 in sub-contractor costs. In accordance with the Corporation Tax Act 2009 (CTA), 65% of that amount was included in the company’s R&D tax relief claim. However, this money wasn’t paid to MSL until installments in February 2015, March 2016 and June 2016. To simplify, GRRL claimed £723,082 in 2013, on the basis of incurring sub-contractor costs, which it had not yet paid. It’s important to note that claims can be made up to two years after the tax year end (i.e. included in the filed return by March 2014, or as an amendment by March 2015). The first installment (£20,833) was paid to MSL in February 2015, but no amended claim was made in time.
Extracts from the relevant legislation relating to sub-contractor payments are shown below:
- s 1053: “a company’s qualifying expenditure on contracted out research and development’ means expenditure which is incurred by it in making the qualifying element of a sub-contractor payment”
- s 1134: “the qualifying element of a sub-contractor payment is the entire payment”
- s 1136: “the qualifying element of the sub-contractor payment is 65% of the sub-contractor payment”
In layman’s terms, 65% of the entire amount paid to the sub-contractor can be claimed if the contractor carried out R&D work, and the company incurred, and paid, costs in the relevant tax year.
GRRL argued that its claim was a “placeholder” that would be validated when payment was made. Effectively it argued that the claim could be submitted and HMRC would wait until payment was made, before accepting the claim. HMRC’s view was that the payment didn’t have to be made during the claim year, just before the R&D claim was submitted. GRRL could have, in that case, claimed the R&D expenditure in an amendment (filed by March 2015) for the R&D sub-contractor services performed in the tax year ended March 2013, provided the costs had been paid by March 2015.
GRRL’s appeal was dismissed. Surprisingly, the tribunal also decided on a judgement that differed from HMRC’s view. The tribunal’s decision was that payment needed to be made within the tax year. It said:
- deductions are given if certain conditions are met, one of which “requires qualifying expenditure deductible in ‘computing for corporation tax purposes the profits of the trade for that period’”
- s 1133: has requirements that “a payment made by the company to another person”
- “those provisions taken together and in the context of the rest of Part 13, give a legislative requirement for a payment to be made in the accounting period for which relief is claimed”
Again, to put it in layman’s terms, a claim can be made if it meets certain requirements, one of which is that payment is made during the tax year. This decision doesn’t alter HMRC’s requirements for future claims or cases, but is a thought-provoking conclusion.
What does this mean?
If nothing else, this case illuminates some misunderstandings that may happen. Most people would agree it’s unrealistic to make a claim and expect HMRC to sit around waiting for payment before accepting and approving it. Equally, if sub-contractors worked an entire year and provided an invoice at the end of that year, and a company pays it the following month, it makes sense for businesses to claim R&D tax relief for the year, even though they are technically paying the next year. This case makes it clear that it’s important to have a firm understanding of R&D legislation, or have someone close who does.
Who We Are:
Swanson Reed is one of the UK’s largest specialist R&D tax advisory firms, offering tax credibility assessments, claim preparation, and advisory services. We manage all facets of the R&D tax relief program in the UK, from claim preparation & audit compliance to claim disputes.