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Advising the pharmaceutical sector on R&D tax relief

Author: Tom Mason

For accountancy firms advising the pharmaceutical sector, R&D tax relief is likely to be a frequent point of discussion with your clients.

Although it is a sector which comes more obviously under the scope of the scheme than others, you and your clients are still likely to encounter uncertainties over eligibility and claim preparation.

Why? In our experience, R&D projects in this sector can be hugely complex with specific expertise required at each stage.

For this reason, we often see projects involving multiple companies and stages of R&D, which can create confusion over which company can claim relief and which activities qualify under the scheme.

Identifying qualifying activities

Quite simply, a lot of R&D happens in the pharmaceutical sector. It is an industry dedicated to overcoming challenges or uncertainties relating to health.

This can, as you may have seen, result in clients assuming that their work comes under the qualifying activities when it doesn’t, or when it is only partially classed as R&D.

As you know, projects claimed under the scheme must:

  • Seek answers to a scientific or technical uncertainty
  • Not be readily worked out by another expert in the field

Qualifying expenditure must relate directly to the project, although it doesn’t necessarily need to be spent on carrying out R&D activities.

For example, your client may be able to reclaim staff costs relating to the project or for certain software, as well as materials and trials of a new product.

The difficulty in the pharmaceutical sector is defining what exactly qualifies as ‘seeking answers to a scientific uncertainty’, since most work done in this industry does that to some extent.

To qualify, your client’s work must seek to make a genuine contribution to the sector and solve a problem, such as a health condition or limit of an existing drug. It generally cannot simply apply an existing solution in a different way.

Identifying who makes a claim

If your client develops a new drug, who claims for R&D tax relief? Consider that your client has worked out the scientific uncertainty behind it, produced a prototype and then engaged a third-party laboratory testing service to trial it on a wider scale.

HM Revenue & Customs (HMRC) takes the view that the party which bears the financial risk of the R&D can claim tax relief on it.

Therefore, in this situation, we would expect that your client could submit a valid claim.

However, what happens if, during manufacturing of the drug, the laboratory found that making it on a large scale was impractical and, in order to fulfil its contract, had to develop a new way of making that type of drug.

Here it becomes more complex. It may be that both parties can claim R&D tax relief on different projects – the customer (your client) for the drug development, and the contractor (the laboratory) for addressing the uncertainty of manufacturing a certain type of drug.

When assessing eligibility for R&D tax relief, HMRC will consider intention alongside financial risk and ownership of intellectual property.

There must now also be a “reasonable assumption” that the customer “intended or contemplated” that R&D would be required to fulfil the terms of the contract.

The purpose of this clause is to make it clear that R&D has been purposefully contracted out and has not been carried out incidentally by the contractor.

HMRC states that clauses requiring a ‘reasonable assumption’ that R&D was intended under the contract are not necessarily satisfied by contracts alone, nor do contracts which do satisfy these clauses need to explicitly state that R&D is needed.

In this case, your client may not be able to claim against the full manufacturing costs if it was not explicit that R&D may be required under the terms of their contract with the laboratory.

Advising the pharmaceutical industry on R&D tax relief can be a challenge. To bring additional expertise into your practice and ensure that all claims are fully compliant with legislation, we recommend that you get in touch with our team.

Contact us today to discuss how we can help you.