Collins Construction: another R&D Tax Credit legal defeat for HMRC

This week saw the publication of another important First Tier Tribunal decision which ruled against HMRC in the contentious areas of subsidised and subcontracted R&D for tax purposes.

I discussed this case with a former senior HMRC inspector, who sees the judgment as reinforcing the principles established in the 2021 Quinn case.

He believes it highlights how HMRC has been holding on to outdated positions without offering any fresh legal reasoning.

(You can read the full judgement document on my LinkedIn page in the “Featured” section here ).

The Case

Collins Construction Ltd successfully appealed against HMRC's decision to refuse their R&D Tax Credit claims for 2018 and 2019.

HMRC argued that the R&D costs were either subsidised or related to activities that had been contracted out to Collins, thereby disqualifying them from R&D relief.

The key points were:

• Subsidised expenditure: HMRC's position was that Collins' clients, who paid for the work, indirectly subsidised the R&D costs. However, following similar logic to the Quinn (London) Ltd case , the Tribunal ruled that standard commercial payments for services don’t count as a subsidy.
• Contracted-out activities: HMRC also argued that the work was contracted out, meaning Collins was merely carrying out activities for clients. The Tribunal disagreed, confirming that the R&D was initiated by Collins and wasn’t required under the terms of their contracts.

The Tribunal allowed the appeal, which confirmed Collins' right to claim R&D tax relief. This ruling clarifies the position around what constitutes subsidised or contracted-out activities when claiming R&D tax relief.

HMRC’s failure to learn from Quinn

Firstly, this case confirms the judgement in the Quinn case regarding the meaning of subsidised expenditure.

That is hardly surprising given that the approach and reasoning of the tribunal judge in Quinn had also been endorsed by the Upper Tribunal in the case of Perenco (2023) .

It is worth returning to the Quinn case for a moment for a comment that was made there to set the scene.

“Moreover it would be wholly out of kilter with the overall SME scheme, if an SME would be denied enhanced R&D relief solely because, in doing what is envisaged by the legislation (namely, utilising the relevant R&D for the purposes of its trade), as is usual and to be expected of an entity carrying out a trade on a commercial basis, it seeks to recover some or all of the relevant costs of the R&D under its commercial contracts with its clients entered into in the course of its ordinary trading activities. Indeed, if HMRC’s approach were to be adopted, the circumstances in which an SME could claim enhanced R&D relief would seem to be confined to those where it has no prospect of exploiting the R&D for commercial gain”

This was a fairly damning dismissal of HMRC’s conceptual subsidy argument. It was therefore surprising to see HMRC, having failed to appeal the Quinn verdict, return to the fray armed with no new arguments except sour grapes and misinformation about the way the legislation expressed the policy behind the relief.

It is a common sense adage that when you are in a hole, you should stop digging, but HMRC seems to have failed to appreciate this.

When HMRC lost the Quinn case, they went on to falsely assert that the judgement was specifically made on the facts and was confined to them, rather than to acknowledge that the case hinged on a detailed examination of the correct statutory interpretation.?

But then to return to the argument with a case on similar facts, after the Quinn approach had already been endorsed at the next level up, and expect a different verdict, seems foolhardy.

HMRC’s misguided approach to subcontracting rules

HMRC’s technical advisors seem to have based their litigation argument on their own (flawed) understanding of the purpose of the legislation rather than on the legislative position. The response of the tribunal was instructive – they regarded this as so irrelevant that they did not even bother reporting what HMRC’s evidence was.

Instead, they issued the salutary reminder to HMRC that “we consider that the purpose of the legislation is to provide relief for R&D expenditure in accordance with the requirements as set out in the relevant statutory provisions” thereby directing HMRC back to the proper question of what the law actually says.

Obviously, the hearing was a substantial one – even though the parties seem to have agreed to accept that all the tests were already satisfied except subcontracting /subsidy.

Despite this radical pruning, the case still required a document bundle of 2,557 pages, together with 25 additional document bundles and authorities totalling 933 pages and skeleton arguments from both parties. The hearing itself lasted two days and generated a transcript of 103 pages!

It is hardly any wonder that many companies are inhibited from taking the litigation route, no matter how unreasonable HMRC’s behaviour seems to be. In this case it was fortunate that the amount at stake was sufficient to justify the company defending its claim.

While the prospect of any success with the subsidised expenditure argument was a forlorn one for HMRC, there was some faint hope for them that they might have secured some progress on the interpretation of the subcontracting requirement.

(It remains a mystery, indicative of HMRC incompetence, why they did not run this argument in Quinn as well, as it was not so self-evidently ludicrous as the one they chose).

HMRC contended that the requirement in the subcontracting legislation “that the expenditure is not incurred by the company in carrying on activities which are contracted out to the company by any person” should be read widely as a general prophylactic to cover activities associated with fulfilling the contract even if they were not the subject of the contract.

It was suggested that if this interpretation was not followed then companies could manipulate the terms of their contracts to avoid falling foul of the requirement.

This is mixing HMRC’s “tactical” analysis with statutory interpretation, which is not the correct approach.

The Tribunal rejected this view by reference to the Explanatory Notes relating to the original legislation which instead favoured the interpretation that the “activities” mentioned in the legislation were the R&D activities rather than the overall commercial contract activities.

This was specific legislation designed to ensure that only one party to an R&D contract for R&D activities could claim for those activities.

The ex-HMRC inspector I spoke with doesn’t think this gives carte blanche to companies to manipulate the terms of their contracts so that R&D activities are not specifically mentioned but are actually mutually understood.

Collins did not contend for the proposition that only the contract wording was relevant and accepted that where there was a reasonable contemplation in the minds of the parties that R&D would be required then the R&D would have been subcontracted.

HMRC “misinterpreting legislation and ignoring legal precedents”

I asked the ex-HMRC inspector for his general thoughts on the problems that have been allowed to develop in recent years with the technical team at HMRC.?

He told me:

“HMRC seem almost to have become committed to carrying out guerrilla warfare against their own legislation. Their tactics are obstruction through enquiry, misinformation through the CIRD manual, and attacks on smaller companies that are not able to support the risk of litigation.

“However, whenever the guerrilla warfare results in a direct confrontation in front of the courts, HMRC is losing.? Something similar will probably happen in due course with the arguments around Paragraph 9(c) of the Guidelines (appreciable improvements).

“It really does seem necessary that at some point the HMRC management team rein in their technical advisors and tell them that their job is to apply the law as written, not to pursue tactics aimed at preventing claims which the technical team think were not intended within their own subjective beliefs as to how an R&D scheme should operate.

“It is also time that HMRC stop trying to change the operation of the law by staff instructions in the CIRD manual which go against the law as enacted and interpreted by the Tribunals.

“I also think there is a need for HMRC to genuinely acknowledge when their policy and interpretation represent a change from past practice, rather than trying to hide this. Any such changes can then be properly discussed which will help all parties arrive at the best understanding of the correct approach to be adopted with claims.

“For example, on the subsidy/subcontracting point, it does not seem possible that HMRC was unaware of the probably thousands of claims that had been agreed on an “own account” basis in line with established policy.

“To assert that there was no such policy was at best ingenuous but looked more like straightforward dishonesty, and this has been damaging to the cooperation between the profession and HMRC in ensuring an open and cooperative approach to getting tax claims right”.

Final Thoughts

I also spoke with Jonathan Yeomans MSc ATT , who spent 32 years at HMRC and now runs Avalon Tax which assists R&D claimants with compliance checks.

Jonathon commented:

"Unfortunately, HMRC appears to have fallen victim to the fallacy of believing their own hype, stubbornly clinging to arguments that were decisively dismantled in Quinn and seeking to re-argue points already determined.

“HMRC's stance, that ‘simply disagreeing with the reasoning of the prior decision is sufficient for this Tribunal to find that there was an error of law and that the decision is wrong’ reflects a narrow and blinkered approach of disregarding anything that conflicts with their desired outcome.

“HMRC was similarly criticised for ignoring the weight of evidence in Get Onbord Ltd recently, and regrettably, this pattern appears indicative of HMRC’s current more general approach to R&D tax enquiries that will be all too familiar to many advisors."

…and finally, finally!

A big credit goes to Adam Spriggs, R&D Tax Director at Zeal Tax and barrister Edward Hellier, along with the team at Fiscale, for working on this case for more than three years. This success is a testament to their dedication and expertise.

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Article written by Rufus Meakin and based on an exclusive interview with a senior ex-HMRC inspector.

Rufus Meakin works with tech companies to help ensure their R&D Tax Credit claims are accurate and defendable.

If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to book an exploratory call here: https://calendly.com/rufusmeakin-uk/r-d-tax-credits-exploratory-call

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