Iain Rankin looks at changes in HMRC’s new simplified claims procedure for research and development, and how small firms may benefit.
Prior to February 2019, making research and development (R&D) claims was something of a minefield for small firms. Some claims were submitted with no more than a single figure included in the tax computation, representing the total qualifying R&D expenditure, while others contained extremely detailed information about the individual projects undertaken and the costs to justify the claim.
Simply, there existed no clear definition of what constitutes R&D in tax legislation, nor guidance on the precise nature of information that should be disclosed when making an R&D claim.
Consequently, take up for R&D claims was surprisingly low. It is estimated that less than 5% of potentially qualifying firms were taking advantage of the scheme.
Current position
In February 2019, in an attempt to encourage more businesses to claim (in particular those that do not wish to use specialist R&D advisers) HMRC introduced a simplified process. This allows small and medium-sized enterprises (SMEs) to use a standardised online template.
By presenting information in a more structured manner it was deemed that the process would not only make things easier but limit the scope of HMRC enquiries and deter spurious claims.
In general, if a company is doing any of the following, and needs to overcome technical uncertainties and challenges in the process, it should consider making a claim for R&D tax credits:
- developing new or improved products or processes;
- investing in technology, including the development of new and improved software for sale or licensing;
- investing in technology as part of the development of a product, process or a device;
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investing in software to make the business run more efficiently.
The new online template
Two sections must be completed. The first is a set of four standard questions, describing the individual R&D project(s):
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What was the scientific or technical knowledge at the start of the project?
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What was the gap in technological knowledge or capability that the project aimed to overcome?
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What types of scientific or technological uncertainties did the company face in achieving the desired advance?
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How did the project overcome the technological uncertainties?
Question 1 requires a description of the situation that existed prior to the commencement of the R&D project that the company plans to improve. This can be measured in relation to a competitor, against the company’s own product or processes or another known external process.
Question 2 is intended to be a reference to the underlying technological advances made by the project. This advancement does not necessarily have to result in a new product or service, so long as a competent professional would recognise the outcome as a significant improvement.
HMRC’s guidance notes give the following as examples of an advance or improvement:
- creating a new process, product, material, device or service that increases the knowledge or capability;
- a visible improvement to an existing process, product, material, device or service such as cost saving or less waste; or
- using science or technology to copy the effect of a current process, product, material, device or service, but in a new or improved way.
Question 3 should include a description of the technical obstacles that were found which had to be overcome to achieve the advances or improvements. A technological uncertainty is one that would be recognised as such by a competent professional, where known methodologies and practices had not previously worked.
HMRC’s guidance notes provide two examples of this. First, when the company does not know if it is possible to create or improve the product or process; and second, when it is possible to create the product or process, but it has proven too costly.
Question 4 asks for a description of the R&D activities undertaken. The response would typically include details of the following:
- the feasibility study and planning of the work;
- the research and development carried out; and
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the testing phase, at the end of the project.
For some advisers, the online R&D template will require a new and different, more structured and succinct, approach to providing information.
The advantage to businesses is that in answering these questions, it should be clear whether a project qualifies for R&D tax credits. From HMRC’s perspective, enquiries about the nature of the project are likely to be reduced as the questions cover many of the standard queries which would normally be raised at the outset of an enquiry.
Section two of the template details the individual project costs. These can no longer be amalgamated and must be provided on a project-by-project basis. This may result in additional work for the company and adviser, though only the total cost for each R&D cost category (salaries, subcontractors, and consumables) requires entering. As it stands, HMRC has confirmed there are no plans to extend this to a more detailed cost analysis.
Companies with more than ten projects must choose which projects to include, since the template has capacity to include a maximum of ten projects. When a claim covers fewer than three projects, details must be provided about all three. If there are more than three, it is required only to provide details of three projects, so long as these represent at least 50% of the total R&D cost.
HMRC anticipates that the online R&D template should be suitable for about 95% of claims.
Potential drawbacks
The online R&D template asks for significantly less detail than many companies and advisers would have included in claims previously. The limited cost basis precludes any analysis of the cost totals to exclude non-qualifying R&D costs.
It is thus difficult to know quite how HMRC can use the information for anything more than a ‘sense check’ based on the expected costs for a specific business sector or activity.
We do not yet know the impact of this on the volume or extent of HMRC enquiries. This may discourage some companies from using the online R&D template.
Furthermore, at the time of writing this article, processing times fall well short of HMRC’s 28-day target.
Summary
The online R&D template asks for much less detail, both in terms of the project description and cost information, than was routinely filed previously.
Using a standardised format should lead to an improvement in both the quality and relevance of the project information. This should make it easier to determine whether a project qualifies for R&D tax credit.
However, there is a risk that the minimal cost breakdown required could lead to a higher likelihood of HMRC enquiry.
Practical tip
On balance, the new online claim process is a positive step towards providing clarity about how to make an R&D claim that can readily be agreed by HMRC. This should provide much needed surety to companies and their tax advisers.
