A “landmark” court judgement has been delivered against HMRC after its denial of £1m worth of SME R&D tax relief to construction firm Quinn London Limited.
HMRC’s denial of the relief was based on its recently tightened interpretation of subsidised R&D expenditure. It contested that, because Quinn’s R&D projects are typically carried out for clients, any expenditure on that project should be treated as subsidised.
Appealing the judgement, specialist R&D tax relief consultancy ForrestBrown argued that HMRC’s interpretation of the legislation was too broad and will narrow the scope of SME R&D tax relief.
Accepting the appeal in favour of Quinn, Judge Morgan stated in her verdict: “It would be wholly out of kilter with the overall SME scheme if an SME were to be denied relief solely because it seeks to recover some or all of the relevant costs under its commercial contracts with its clients.
“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.”
HMRC had adjudged that, despite meeting the criteria of the SME R&D relief scheme, Quinn’s subsidisation of expenditure meant it was only eligible for the far less generous R&D Expenditure Credit (typically claimed by larger organisations).
Over the period in question, the difference in value between the two was calculated to be worth more than £1m.
“This is of wider significance because HMRC’s approach risked a significant narrowing of the ability of all SME’s to access this relief, the purpose of which was to encourage innovation,” said Lee Ellis, partner at Stewarts, the law firm representing Quinn.
“The ruling also enables Quinn to continue to access SME R&D tax relief for future projects.”
“Much-needed clarity”
According to Jenny Tragner, technical director at ForrestBrown, the case acted as a valuable demonstration of why HMRC’s newly narrowed scope is misjudged, and that its guidance on the matter is lacking in clarity.
“The reason we flagged it as significant at the time was that we saw the interpretation itself could be applied much more broadly to a really significant proportion of SME claims,” she said.
“It highlighted that if read literally, that particular section of the legislation that HMRC changed their interpretation on wasn’t particularly helpful and there wasn’t detailed enough guidance around it to provide clarity.”
Tragner noted that 80,000 businesses are currently accessing R&D tax relief in the UK. The Quinn case raises questions as to how many of them are being denied valuable relief, and how many understand the legislation on a detailed enough level to challenge HMRC on such matters.
“Any uncertainty is potentially damaging for businesses that are accessing relief, and it also creates an environment that is open to exploitation.
“What we would hope is that it would lead to better guidance and clarity from HMRC, and that it will provide an interpretation on which HMRC concede, accept and are willing to apply to other cases.”
James Dudbridge, director at ForrestBrown, suggested that SMEs view this as a wake-up call to seek high-quality advice.
“We are concerned that some businesses might have been unwittingly affected by this incorrect interpretation where they haven’t had access to specialist advice.
“We would urge them to contact only regulated firms who have the specialist knowledge in this area to review their circumstances.”
This could be a “new era for the incentive”, adds Tragner, arguing R&D has historically been perceived as either “super generous and really easy” or “some sort of loophole”.
It’s neither of those things, she argues.
“My advice would be to be aware of R&D tax relief rather than afraid of it but afford it the respect that it deserves. It’s a complex area of tax and clients should be well-advised.”
R&D in the Autumn Budget
The R&D-related measures included in this year’s Autumn Budget prompted a mixed reaction from the industry.
While the inclusion of data acquisition and cloud computing in the scheme has largely been met with approval, new territorial restrictions excluding foreign R&D activity by UK-based companies have proven less popular.
“The decision to only reward UK companies for UK-based R&D activity is curious,” said Stuart Weekes, corporate tax partner at Crowe.
“UK PLC should benefit from R&D investment wherever it takes place. It may be that continuing to enlist R&D resource overseas is the most cost-effective way for those companies to operate.”
Chris Sanger, head of tax policy at EY, called the Chancellor’s actions “two-handed”.
“Keeping the rules of the R&D regime current to reflect how businesses operate is vital to the continued success of the credit,” he said.
Following recent criticism of HMRC’s controls around R&D claims, a forthcoming consultation document is expected to address how abuse and compliance in relation to the scheme are to be addressed by the government.