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Subcontracting Expenditure Merged R&D Rules

Despite the hopes of many for a last minute reprieve it has now been confirmed that the new merged R&D scheme will take effect for periods starting on or after 1 April 2024.

The headline measure is that relief under the merged R&D scheme will be delivered through a taxable expenditure credit, in a similar way to the existing RDEC scheme for all eligible companies, with separate rules for loss-making R&D intensive SMEs based on the existing scheme.

However the changes will also see significant changes to the subcontracting rules that are, if anything, more significant.

  • These rules will be based on the SME scheme, with the claimant company able to include subcontractor costs in its R&D claim, however companies undertaking contracted out R&D will not be eligible to make a claim
  • With so much riding on whether R&D is subcontracted or not, the government has attempted to provide some clarity by introducing a new definition:

A person “contracts out” research and development if:

  • They enter into a contract under which activities are to be undertaken for them (this may include the provision of any goods or services)
  • The activities undertaken in order to fulfil the contract include R&D; and
  • It is reasonable to assume that the person intended or contemplated that R&D of that sort would be undertaken in order to meet those obligations.’

The key point is clearly when it is reasonable to assume that the person engaging the subcontractor ‘intended or contemplated’ that R&D would be required.

The concern was that large companies would use their size and bargaining power to claim all R&D was intended, but HMRC have clarified that ‘intended or contemplated’ is meant to be a high threshold, and will require the customer to understand and be able to able to explain the details of the R&D required. This would require a detailed technical understanding of the field, and not just that the work was ‘challenging’

So what does this mean?

With HMRC undertaking an increasing level of enquiries, it is likely that they will require increased evidence to demonstrate entitlement to relief, meaning that companies should review their contractual arrangements to ensure they have the evidence to support claims.

For companies subcontracting out work – they will need to be clear when entering into any contract that the contract and any pre-contract documentation, as well as the supporting circumstances under which the work is to be carried out reflect the fact that they intended for R&D to be undertaken. The supporting documentation may be internal or external, as long as the company can produce contemporaneous evidence to support their case if required by HMRC

For subcontractors – similarly, if they believe they are undertaking any R&D of their own volition, they should ensure that the contract and pre-contract documentation is clear as to the scope of work and expectations of their customer

If any companies would like to discuss this with one of our expert Innovation and R&D team, pleased don’t hesitate to get in touch.

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