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A recent first-tier tribunal ruling highlights the importance of understanding the specific criteria for claiming R&D tax credits
In Collins Construction Ltd [2024] TC 09332, the first-tier tribunal (FTT) ruled in favour of the appellant company, holding that its expenditure on research and development (R&D) – incurred to fulfil building fit-out and refurbishment contracts at its own financial risk – was not ‘subsidised’ within the meaning of sections 1138 and 1052(6) of the Corporation Tax Act (CTA) 2009. Furthermore, the expenditure was not for activities ‘contracted out to’ the company, as per section 1052(5) of the CTA 2009. Therefore, the tribunal allowed the company’s appeal for R&D tax credits, amounting to approximately £3.2m.
The appellant, Collins Construction Ltd, an SME specialising in building fit-out and refurbishment, engaged in several contracts where it bore the financial and development risks of delivering agreed-upon projects. During the course of these projects, it occasionally became clear that R&D was necessary to achieve the required results. While its clients were not involved in the technical aspects of the projects, Collins Construction took it upon itself to innovate and find solutions for any technical challenges. No contractual provisions mandated or funded R&D activities, and the company retained intellectual property rights to any innovations it developed.
HMRC issued closure notices, rejecting the claims for R&D relief. The notice for 2018 rejected a claim of £573,056.72 and imposed £471.99 additional tax. The 2019 closure notice denied a claim for £2,670,972.94, arguing that:
- The R&D expenditure was ‘subsidised’ by the payments made by clients under the building contracts, as per sections 1052(6) and 1053(5) of the CTA 2009.
- The R&D expenditure was for activities ‘contracted out to’ the company by clients, as outlined in sections 1052(5) and 1053(4) of the CTA 2009.
The company appealed both points.
Whether expenditure was ‘subsidised’
Section 1138(1) of the CTA 2009 defines subsidised expenditure in the following terms:
Expenditure is considered subsidised if:
- a notified state aid was obtained in relation to the expenditure
- a grant or subsidy was received for the expenditure
- the expenditure was otherwise met directly or indirectly by a third party.
HMRC argued that the R&D expenditure was ‘met’ indirectly by the company’s clients since they paid for the building fit-out and refurbishment projects.
The tribunal, however, rejected this argument, referencing its decision in Quinn (London) Ltd [2021] TC 08321, which had similar facts. In that case, the company contracted to perform specified works for an agreed price, and while R&D costs were included in the company’s pricing, there was no direct agreement with clients to pay specifically for R&D activities. The tribunal emphasised that, under the principle of ‘judicial comity’, it was appropriate to follow the reasoning in Quinn.
Furthermore, the tribunal noted that the word ‘otherwise’ in section 1138(1)(c) of the CTA 2009 was intended as a catch-all to encompass situations where funding was provided for expenditure in a way similar to state aid or grants, not for payments made under a commercial contract. The tribunal found no evidence of a clear link between the clients’ payments and the R&D activities, thereby ruling that the expenditure was not ‘subsidised’.
Whether expenditure was on activities ‘contracted out to’ the company
The tribunal also rejected HMRC’s argument that the R&D expenditure was for activities ‘contracted out to’ the company. Under the contracts with its clients, there was no explicit or implicit requirement for the company to perform R&D. The company undertook R&D at its own economic risk, and there was no provision in the contracts for payment in respect of these R&D activities.
The contractual relationship between the company and its clients was strictly for the provision of specified building works for an agreed price. The price paid did not include any specific reimbursement for R&D costs, and any innovations or intellectual property resulting from the R&D were retained by the company. The tribunal, following the reasoning in Quinn, concluded that there was no contractual arrangement for the company to carry out R&D on behalf of its clients.
Conclusion
The tribunal allowed Collins Construction Ltd’s appeal, ruling that the company’s expenditure on R&D was not subsidised by its clients nor was it for activities ‘contracted out to’ the company. As a result, the company was entitled to the R&D tax credits of £3.2m that had been denied by HMRC. This decision highlights the importance of understanding the specific criteria for claiming R&D tax credits and the need for businesses to demonstrate that their R&D activities are not directly funded or contracted out by clients.
HMRC has decided not to appeal the decisions and is currently assessing the wider implications of the ruling. It plans to release additional guidance on the matter in February 2025, which we will be highlighting in In Practice. Businesses are encouraged to keep an eye on the updated guidance. HMRC will also contact affected customers in January 2025 to provide information on the next steps.