R&D Tax Relief: Collins Construction’s Landmark Victory at First Tier Tribunal Against HMRC’s Restrictive Approach
Kanika Mishra Pathak · Posted on: December 4th 2024 · read
Kanika Mishra Pathak, Tax Director and Sarah Bandy, Assistant Research and Development Manager at MHA discuss the landmark case centered on Collins Construction Limited ("Collins"), a specialist in refurbishment and fit-out projects, taking on HMRC’s controversial interpretation of subcontracted and subsidised R&D.
Collins appealed closure notices from September 28, 2021, which denied their R&D tax relief claims for two periods ending June 30, 2018, and June 30, 2019, further challenging HMRC’s stance in a growing series of disputes that questions its restrictive approach.
The hearing occurred over two days in December 2023, with a judgment issued on October 21, 2024.
Key Issues
The First-Tier Tribunal (FTT) identified two primary issues:
- Whether the R&D expenditure was considered "subsidised" under section 1138 CTA 2009.
- Whether the expenditure was incurred in "carrying on activities which are contracted out" under sections 1052 and 1053 CTA 2009
The Subsidised Condition
The term "subsidised" is defined under section 1138 CTA 2009, which specifies that expenditure is "subsidised" if:
- A notified State aid was received for the expenditure,
- A grant or subsidy was received, or
- The expenditure was "otherwise met directly or indirectly by a person other than the company".
HMRC argued that since Collins received payments from clients for completed projects, these payments indirectly "met" the R&D expenditure, thus disqualifying it from tax relief. HMRC contended that the contractual relationship between Collins and its clients was a straightforward commercial arrangement, whereby Collins' clients indirectly incurred the R&D expenditure through project payments.
Collins, however, argued that this interpretation misrepresented the nature of the contractual agreements. Collins maintained that client payments were for specific project deliverables, not as direct or indirect reimbursement of R&D expenditures, asserting that its clients did not "subsidise" the R&D work since payments were based on predetermined prices and project scopes unrelated to the R&D costs.
The Tribunal leaned on the interpretation in Quinn (London) Ltd v HMRC, which had ruled that if an SME receives an agreed price under a commercial contract without a clear link to specific R&D costs, the expenditure should not be considered "met" by the client. The Tribunal concluded that, in Collins’ case, the client payments did not constitute subsidised R&D under section 1138, as there was no explicit provision or link between client payments and the incurred R&D expenses.
The Contracted-Out Condition
The second issue examined was whether the R&D expenditure related to "contracted out" activities, according to sections 1052 and 1053 of CTA 2009, which would disqualify them for relief under the SME scheme.
HMRC argued that Collins was contractually obligated to provide specific deliverables, which included activities that could be categorised as R&D. Hence, HMRC claimed that these activities were effectively contracted out to Collins, as Collins incurred the R&D expenditure to fulfill its contractual commitments to the client.
Collins countered that these expenses were unplanned, arising only during the project due to unexpected challenges, such as addressing a reverberation issue with a custom acoustic solution and creating a zig-zag brick pattern when the original cladding material was unavailable. These R&D activities, Collins argued, were independent R&D efforts undertaken to solve unforeseen problems not specified in the contract.
The Tribunal agreed with Collins, affirming that these activities were voluntary, problem-solving measures, not “contracted out” as per the statute.
Conclusion and Analysis
The Tribunal ultimately ruled in favor of Collins, allowing the appeal on both counts. The Tribunal found that Collins’ R&D expenditure was neither "subsidised" nor "contracted out" and thus qualified for R&D tax relief under CTA 2009. The Tribunal’s decision rested on a purposive interpretation of the legislation, affirming that the relief aims to support independent R&D undertaken by SMEs without reimbursement from third-party clients.
This case underscores the importance of clear distinctions between commercial contractual arrangements and R&D activities undertaken independently by companies to qualify for tax relief, particularly for SMEs engaging in unplanned R&D in response to project complexities.
This case contributes to a complex landscape in the area of subsidised and subcontracted R&D, with other FTT cases such as Quinn (London) Ltd v HMRC and Hadee Engineering Co Ltd vs HMRC presenting seemingly conflicting views on the subject. This is further complicated by the upcoming changes alongside the introduction of the Merged Scheme, meaning that claimants will need to carefully evaluate each R&D claim for upcoming accounting periods to ensure that they are compliant with the applicable guidelines.
If you are considering making an R&D claim but are concerned about whether your projects could be subsidised or subcontracted out, our R&D tax specialist team can provide clarity and ensure that you are complying with the most up to date guidance in this nuanced area.
