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I contract therefore I am (eligible for R&D tax relief)

Author: Tom Mason

Do your clients understand the rules and terminology around contracted-out R&D? How can you best communicate this to them?

These are challenges we come across regularly, reflecting the need among accountancy firms (and your clients) for clarity around what we mean by ‘contracted-out’ or ‘contracted’ R&D and when it is eligible for tax reliefs.

A change in terminology

In March 2024, the Government issued new guidance as to how it would refer to R&D projects where one party is contracted to carry out qualifying work on behalf of another party.

Previous regulations referred to R&D activities being carried out by a ‘subcontractor’ on behalf of a ‘contractor’ – i.e. the party issuing the contract.

However, the latest regulations refer to R&D activities carried out by a ‘contractor’ – i.e. the party carrying out the work under the contract – on behalf of a ‘customer’.

This change in language should be communicated clearly to clients seeking to claim R&D tax relief because it relates to which party is eligible to claim relief under the scheme.

Which party is entitled to claim reliefs?

You may have already discussed with clients that, under the latest rules, contracted R&D costs are eligible for R&D tax relief.

For the first time, R&D tax regulations explicitly give the right to claim to the customer, the party which bears the financial risk for the project.

The merged scheme also effectively puts an end to the concept of ‘subsidised’ R&D from a contractor/customer perspective – as well as removing relief restrictions on subsidised R&D expenditure.

Does the customer always bear the risk?

Superficially, yes – the customer which contracts its R&D activities out to another company always bears the financial risk of doing so. They also typically own the intellectual property around the innovation, entitling the customer to any tax reliefs which come out of this work.

However, it isn’t always so straightforward.

You may well work with clients which carry out R&D activities on behalf of a customer but are in fact eligible to make a claim themselves.

Aside from intellectual property and financial risk, HM Revenue & Customs (HMRC) also considers intent as a deciding factor as to which party can claim R&D tax relief.

The assumption of intent

Any R&D carried out must be explicitly intended within the contract or agreement.

Your clients should note the word ‘intended’. R&D activities do not have to be explicitly required by the contract, but there must 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 is to make it clear that R&D has been purposefully contracted out and has not been carried out incidentally by the contractor.

If it is found to have been carried out incidentally, then the contractor may be able to claim R&D tax relief in place of the customer.

Whether your client is the customer or contractor, the best way to demonstrate intentionality is to ensure that the ‘contracted’ nature of the R&D activity is made clear at every stage and that evidence of this communication is readily available.

For further support with contracted R&D, please contact us today.