The cases consider the nature of subcontracted work and subsidised expenditure for the purposes of the R&D tax relief regime for small and medium-sized enterprises (SMEs) that existed prior to the introduction of the merged R&D scheme.  

In both cases, the company incurred expenditure in carrying out R&D activities to fulfil contractual obligations for major clients. The FTT found that: 

• the expenditure had not been subsidised by the clients; and
• the R&D activities had not been contracted out to the company by the clients.  

HMRC decided not to appeal the decisions and has updated its guidance to reflect its current view. 

Subsidised expenditure  

HMRC’s guidance (CIRD81650) says that payments received are not considered to subsidise a company’s R&D activities unless the payment is “specifically linked to those activities”. HMRC’s view going into the FTT cases was that it was enough for the appellants’ clients to indirectly meet the cost of R&D expenditure through project payments for that expenditure to be treated as subsidised. This change in guidance therefore indicates a significant shift in view. 

The guidance then goes on to set out a non-exhaustive list of situations in which expenditure would and would not be treated as subsidised. 

HMRC considers that expenditure would be subsidised expenditure in the following circumstances: 

• The funding is related to the R&D expenditure, but the company provides nothing in return or provides something that does not represent a commercial return to the funder.   
• There is a clear link between the provision of those funds and the expenditure incurred on the R&D project. This would include situations where, for example, funding is routed via connected or third parties. 

The first of these situations leaves open the question as to what represents a “commercial return”. For example, if a funder believes that it is not getting good value for money from a contract, could HMRC seek to treat this as a subsidised arrangement? 

The guidance now specifically states that “where a company carries out R&D on its own account and subsequently sells goods or services developed as a result of that R&D, receipts from those sales will not be considered to meet the expenditure incurred on the R&D.”  

This is a welcome change as it indicates that income generated from sales cannot be treated as a subsidy unless there is a clear link between that income and the expenditure on R&D. 

Contracted-out R&D 

The guidance (CIRD84250) now states that the terms of the contract between the company carrying out the R&D activities and the principal are not the only factor to consider in determining whether the R&D activities have been contracted-out. It goes on to list other factors to consider in order of importance, as follows:  

• If the R&D is only incidental to the supply of a product or service to the principal, then this indicates that the R&D has not been subcontracted out by the principal to the company carrying out the R&D.
• If the company has only a limited degree of autonomy over the way it carries out its R&D activities, this could indicate that those activities have been subcontracted by the principal.
• If the company has only limited financial risk in undertaking the R&D work, this is an indicator that the work has been subcontracted to it.
• If the company retains any intellectual property arising from the R&D project, this would be an indicator that the R&D work was not subcontracted. 

The guidance then sets out a number of hypothetical scenarios and confirms whether or not it believes these would constitute subcontractor arrangements, based on the factors above. 

Open enquiries 

As previously reported, HMRC has written to those taxpayers it believes are affected by the FTT decisions and has said that it will seek to close those enquiries by 30 June 2025, although timescales could extend beyond this deadline, particularly where enquiries remain open for issues beyond the FTT judgments. 

ICAEW’s view 

While we would have liked to see more detailed commentary on what constitutes subcontracted arrangements, we believe that the changes to the guidance are very helpful in setting out the broad principles to consider in determining whether expenditure has been subsidised and work has been contracted out. 

Further information 

• Collins Construction Limited v HMRC [2024] UKFTT 951 (TC)
• Stage One Creative Services Limited v HMRC [2024] UKFTT 1059 (TC)

Learn more about this issue, and other developments in R&D tax relief, by listening to a recent episode of the Tax Track podcast.