David Pickstone is a partner and Anastasia Nourescu is a senior associate at law firm Stewarts
HMRC has recently intensified its scrutiny of research and development tax relief claims, targeting inadequate submissions from rogue advisers and seeking to narrow the interpretation of the rules around subsidised and contracted-out R&D.
Construction contractors, who often work on complex innovation-driven projects, are particularly exposed to this heightened oversight. With recent rule changes and evolving case law, it has never been more critical to ensure R&D tax relief claims are robust, compliant and well-documented.
What is R&D tax relief?
R&D tax relief incentivises innovation by providing tax savings or credits to companies investing in projects that seek an advance in science or technology by resolving uncertainty. Until recently, two schemes were available: the SME scheme, offering enhanced tax deductions or credits to small and medium-sized enterprises, and the Research and Development Expenditure Credit (RDEC), a tax credit for larger companies and some SMEs that did not qualify for the SME scheme.
“Contractors should take a robust approach to disputes with HMRC in light of recent case law”
Access to the relief has always been restricted by rules around subsidised R&D and contracted-out work. Subsidised R&D, where businesses received external funding or grants for their activities, was generally excluded from the SME scheme, with the expenditure instead falling under the less generous RDEC. Relief was also restricted in respect of R&D contracted out to another person.
Since 1 April 2024, the SME and RDEC schemes have merged, simplifying the rules but introducing stricter criteria for contracted-out R&D. Only the party deciding to carry out the R&D and bearing the risk can claim relief. Where R&D is carried out under contract, the customer can claim relief. Contractors who wish to claim relief must now demonstrate that their R&D was not contracted out to them – that it was not intended or contemplated under the terms of the contract.
Subsidised and contracted-out R&D
Recent tax tribunal cases highlight how HMRC’s interpretation of these rules has been challenged.
In Quinn (London) Ltd v HMRC (2021), HMRC argued that R&D undertaken during construction projects was subsidised by customers, as it formed part of the overall contract price. The tribunal disagreed as it found no clear link between the R&D expenditure and clients’ payments. It upheld Quinn’s claim.
Similarly, in cases involving Collins Construction Ltd and Stage One Creative Services Ltd, contractors developed innovative solutions for clients while delivering services. In both cases, HMRC claimed the work was subsidised. However, the tribunal found no evidence linking the customer’s payments to the R&D costs, reinforcing the fact that R&D is not automatically subsidised just because it occurs under a commercial contract.
In Stage One’s case, HMRC further argued that the R&D was contracted out, as it arose from fulfilling contractual obligations. The tribunal rejected this, ruling the R&D was incidental to the delivery of services and not explicitly required under the contract.
These decisions emphasise that R&D conducted as part of service delivery is not automatically subsidised or contracted out. However, they also highlight HMRC’s aggressive approach, which may extend to the new rules. Contractors must be prepared to defend their claims by demonstrating clear distinctions between commercial obligations and qualifying R&D.
What contractors need to know
Contractors with ongoing disputes under the old schemes should take a robust approach to their disputes with HMRC in light of the recent case law, and push back on any attempt by HMRC to take a narrow approach to the subsidised and contracted-out restrictions.
Clear documentation and robust arguments continue to be essential to defending claims. Under the new rules, contractors must carefully structure and document agreements, ensuring the scope of work is explicitly defined during contract negotiations. Relief will only be available to contractors for R&D that was not intended or contemplated when the contract was entered into. Maintaining detailed records and working with experienced advisers will be critical to reducing disputes and safeguarding claims.
HMRC’s scrutiny of R&D claims shows no signs of easing, and the 2024 changes will likely bring fresh challenges. By learning from recent legal developments and adopting rigorous practices, contractors can minimise risks, protect their claims and continue to benefit from R&D tax relief.
