HMRC Updates Guidance for SMEs

After losing two cases at First-Tier Tax Tribunal, HMRC has updated its guidance to SMEs regarding subsidised expenditure. This will affect some claimants going forward as they continue to make claims through the SME scheme for R&D tax relief.

However, with the new Merged Scheme applying to all accounting periods beginning on or after 1 April 2024, these rules will only be relevant to those who have not yet filed their claims through the SME scheme.

Background to the Changes

At the end of 2024, it was announced that a tribunal had found in favour of the taxpayer in two landmark cases for the R&D Tax Relief scheme. In Collins Construction Ltd v HMRC and Stage One Creative Services Ltd v HMRC, the First-Tier Tax Tribunal (FTT) found that both SMEs had indeed carried out qualifying R&D in the course of completing projects for clients.

HMRC had argued that, in both cases, the R&D work that the SMEs completed was “subsidised” by their clients, and thus not qualifying. However, the FTT found that the R&D work was carried out separately from the contracted work. This was the decision of the SMEs to undertake the R&D and it was not paid for by their clients.

In December, HMRC announced that it was considering the wider effects of these decisions, particularly on other ongoing compliance checks. It has since published its review of the guidance on the topic of subsidised expenditure.

New Subsidy Guidance

The new guidance only affects claims made through the SME Scheme, as HMRC announced separate guidelines for accounting periods beginning on 1 April 2024 (i.e., under the Merged Scheme).

Contracted R&D

Where the R&D activities are not contracted to the company, payments received from the principal are not considered to subsidise the company’s R&D activities “unless the payment is specifically linked to those activities”.

R&D that is not considered subsidised:

HMRC’s new guidance has a non-exhaustive list of instances that would not be considered subsidised expenditure (i.e., eligible R&D):

• Companies that carry out R&D and then sell on the results of that R&D later.
• Companies that carry out R&D and have already sold on the results of the R&D prior to the project completing.
• Companies that receive payments from a contract but the R&D work they carry out is not part of the contract.

The last point is the key point within the FTT decisions. On that basis, HMRC released an example of how this last point could be applied.

Company A, a building company, is contracted by Company B, an accountancy firm, to replace the roof of Company B’s office building.

The contract only specifies that Company A must deliver a roof in a specific style using certain materials.

Company A discovers that it needs to complete R&D on the modern, approved fittings for them to work effectively on the roof, due to the age and exposure of the roof. This was not identified in negotiations and does not form part of the contracted terms. Company A chooses to undertake this R&D in order to be able to deliver the rest of the services.

Company A can claim for this R&D work, even though payments from Company B cover all expenditure related to carrying out the contract, as the R&D is incidental to the project and the “payment is not specifically linked to those activities”.

R&D that is considered subsidised:

HMRC also provided a non-exhaustive list of examples where R&D is considered subsidised.

This includes:

• Companies that are funded to carry out R&D, but the company does not provide results to the funder (e.g., in failed projects).
• Companies that have a clear link between funds and expenditure on R&D (e.g., funding being routed via connected or third parties).

Grants and State Aid

Projects funded by state aid or grants have never been eligible under the SME scheme and the updated guidance maintains this.

Fortunately, costs not covered by grants are not subject to the restriction. This means that if your grant funding does not cover the entirety of your project costs, the R&D costs that the company funded will be eligible for the SME Scheme. For example, for an R&D project that is 70% funded by a grant, 30% will be financed by the company and thus eligible for the SME Scheme.

The RDEC Scheme is not subject to the state aid rules, which means that any portion of expenditure funded by notified state aid or any other form of grant can be claimed under RDEC, albeit at a lower rate than through the SME scheme.

HMRC has also specified which government supports meet the definition of notified state aid:

• Coronavirus Business Interruption Loan Scheme
• Coronavirus Large Business Loan Scheme
• Bounce Back Loans
• Recovery Loan Scheme

If these loans were used to fund any R&D projects, then the claims would be ineligible for the SME scheme. However, where state aid is used as a general support and not used to fund the R&D project, the projects may still qualify under the SME scheme.

Where necessary, companies may need to apportion the amount of subsidy, so that only the portion that is used for R&D is put through the RDEC scheme.

How does this affect claimants?

Some companies may have ongoing compliance checks which are under review due to the ambiguity around subsidies prior to this updated guidance. HMRC should have reached out to discuss this with you already.

If you have any concerns or uncertainty with your compliance check, we offer a HMRC Enquiry Support Service. We’ll review your claim and plan your response strategy.

For companies planning their current claims, we recommend that you assess your contracts to ensure they meet the above conditions.

Questions? Download our eBook!

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We’re always happy to chat R&D tax credits, so give us a call or drop us an email if you have any questions.