HMRC seeks to restrict claimable R&D Tax Credit costs

HMRC has recently introduced important new guidance that R&D Tax Credit claimants are expected to follow when preparing an R&D claim.

As I wrote in my previous article , if followed correctly, the new Guidelines for Compliance (GfC3 ) give R&D claimants an opportunity to protect themselves and make it much harder for HMRC to reject a claim.

I now take a deeper look at what the new GfC3 are seeking to achieve and find that, as well as looking to reduce the number of poor quality claims, it is highly probable that HMRC is also seeking to limit the amount of R&D expenditure that can be claimed.

Documenting the advance planning of an R&D project

The GfC3 focus heavily on record keeping and the idea that each technological uncertainty can be planned for and tracked in a linear way. It suggests that HMRC generally expects that there should be documentation of an R&D project prepared in advance of undertaking the work. This can demonstrate that the work is being conducted according to a plan and so is being pursued systematically.

The new GFC3 asks claimants to:

• “Write down exactly which uncertainties you need to resolve and the steps you plan to take to resolve them”
• “Identify exactly where each uncertainty began and would end”
• “Set out the plan for resolving each uncertainty or group of uncertainties”

The idea in the GfC3 that there are uncertainties that can be pursued linearly appears to mean that HMRC now wants companies to be able to describe their exact uncertainties at the beginning of a project.

HMRC also seems to expect claimants to work on and resolve each uncertainty separately, but in practice companies are always going to be facing more generic uncertainties at the start of a project, and the route to solving them will only evolve into more specific areas as the R&D work progresses. This cannot necessarily be predicted in advance. You don’t know in advance which problems will prove most challenging, or what pitfalls you will encounter on the way.

While the GfC3’s reference to proportionality of record keeping is helpful, the overall mindset is wrong. R&D work often proceeds on a number of uncertainties in conjunction, with results being aggregated in terms of overall effect. You start by making a model of your expected solution and then you test it. If it fails, you have to establish the cause of any failure, and then tackle it, so you have to change your plan constantly based on your experimental results instead of following a fixed plan from start to finish.

This is the actual nature of research and development, which the GfC3 seemingly fail to understand.

The GfC3 also asks claimants to “write down exactly what advances you are seeking”.? While it is necessary to identify the nature of the advance being sought, the word “exactly” may not be appropriate, as the characterisation of the advance may change as a project evolves.

There are also many different ways of characterising an advance – it may include elements of new knowledge, and/or of going beyond current capability and/or of appreciably improving existing systems. Therefore, the initial characterisation of an advance may need to be more general rather than exact.

The direction of the advance may well become clearer as work becomes focused on particular avenues, but does HMRC expect the company to keep revisiting the advance to define it more precisely?

As explained below, it seems likely that this focus on early and complete documentation is a prelude to seeking to limit the amount of eligible R&D that can be successfully claimed.

However, despite the above criticisms of the GfC3 guidance, it does seem the case that completing sensible documentation of the project in advance (and as far as practicable in line with HMRC wishes) will go a long way to supporting the validation of the claim and will help resist HMRC suspicions that R&D is often only claimed in hindsight after interventions by predatory R&D advisors.

Attempting to narrow the activity that can successfully be claimed as R&D

The new guidance on expectations and documentation is sometimes in contradiction to the reality of how R&D is actually done. As well as limiting the number of poor claims, it also appears likely that HMRC has a mindset of wanting to limit the quantum of claims, no matter what the Guidelines defining R&D say.

For example, they say recordkeeping is only a recommendation, but that it will help a claim get approved, so HMRC seem to be preparing the ground for denying acceptance on the grounds that they don’t have enough information to accept the claim because the exact uncertainties and the start and end points weren’t clearly defined in a plan.

The GfC3 seems to depart from the existing 2004 and the updated 2023 BIS Guidelines defining R&D by stating that:

“It may be helpful to think of the attempt to resolve [technical] uncertainties as sub-projects that may qualify for R&D relief. An identified sub-project may qualify for tax purposes. This does not mean that other costs incurred on the larger project qualify as part of a claim”.

This suggested approach, together with the expectation that uncertainties will be exactly defined with individual plans as to how they will be resolved, suggests that HMRC wishes to cut into the body of an R&D project and split the qualifying work into narrower elements aimed only at specific technological uncertainties that can be narrowly defined.

This is not the approach used in the Guidelines which state that the R&D project consists of “all the activities that collectively serve to resolve the scientific or technological uncertainty associated with achieving the advance”.

HMRC expectations include that you should: “briefly explain how the approach to resolving each uncertainty or group of uncertainties was a project or sub project”.

This suggests HMRC may have even lost sight of the definitions in the Guidelines. A project is defined by seeking an advance, not by the approach adopted to resolve each uncertainty.

HMRC also asks claimants to:

“Name the exact uncertainties the projects were seeking to resolve… Identify exactly where each uncertainty would begin and end”.

Technological uncertainties often arise from trying to juggle multiple things together or integrate them when the technological requirements are pulling in different directions.

If you seek to break this down to just the nub of the technical issue in each case then you risk losing all the integration and coordination complications.?

Solving an individual uncertainty is not the end of the story. The real challenge in many R&D projects is finding a solution that works well with the rest of the technology system and that can be successfully integrated into it in a cost-effective, reliable, and reproducible way.

This new focus on individual uncertainties may lead HMRC to wrongly suggest that the best way to integrate matters is not a precise technological uncertainty but amounts to a more general business uncertainty, which was not part of the plan.

Uncertainties are also commonly pursued as composites, for example by the development and testing of prototypes, which are tested for overall performance, and the uncertainties are not pursued and ticked off individually with separate plans for each one. They are not considered finally resolved until the prototype as a whole is working satisfactorily, and so there is no need to revisit them.

It may be the case that by focussing on exact characterisation and planning for each uncertainty HMRC is trying to push the start of the qualifying R&D project back until the technological uncertainties have already been part explored, and more specifically itemised?

If so, this would run counter to the previous recognition that establishing the technological requirements for the project is part of the R&D process (as in para 36 of the DBIS Guidelines)

Defining a Competent Professional (CP)

In general, the GFC3 focus on the requirements to be a CP together with a recognition of the CP’s role in identifying the R&D is welcome, as is the indications of how a CP status may be demonstrated.

If a valid CP can be identified and they can confirm the advances and uncertainties in a format as close as practicable to the expectation in the GfC3 then that should make agreement of the claim much easier.

The GfC3 seeks to define the meaning of a CP.? However, it must be remembered that a CP has never been defined in statute and so takes its ordinary meaning.

The GfC3 approach is not bad, but there are some caveats.

For instance, one of the criteria is that a CP “must have…a successful track record” however this may not always be the case because some problems are so difficult that people may have been working to solve them for years. This doesn’t mean they are not Competent Professionals, just that they’ve be working on something that’s particularly difficult.

A CP may also have been previously working as an expert in academia so may not have any track record in a commercial field.

Conclusion

The new guidelines set out stricter requirements for documentation and planning, which may make it more difficult to qualify for R&D Tax Credits.

However, if there is convincing contemporary documentation, then it seems unlikely that an R&D claim will encounter significant obstacles later.

The new guidelines also suggest that HMRC may want to split qualifying R&D work into smaller, more narrowly defined elements, which could result in genuine R&D costs having to be excluded from a claim.

R&D claimants will definitely need assistance in how to express technological advances and uncertainties, set boundaries and monitor costs but if the work is set up well at the outset it ought to make the work needed to finalise the claim much easier.

Article written by Rufus Meakin

Rufus Meakin helps companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.

If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to call me on 0794 110 3285.

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