R&D claim upheld by Tax Tribunal

In Collins Construction Ltd v HMRC [2024] TC09332, the First-tier Tribunal (FTT) upheld the company's claim for research and development (R&D) relief rejecting HMRC's claims that the expenditure was "subsidised" or tied to "contracted out" activities.

Background

Collins Constructions Ltd (CCL) is a specialist contractor engaged in refurbishment and fit-out projects, primarily focused on high-end commercial fit-outs, leisure developments and medical refurbishments. Its core service involves providing specified works for a pre-agreed price, with detailed terms and conditions set out in construction contracts entered into with its clients.

CCL frequently works with clients who present concept designs, which CCL then prices, offering cost certainty before the project begins. CCL assumes the financial and development risk in delivering these projects. Often, the delivery process reveals the need for new solutions to realise the original concept design, which CCL is responsible for developing and implementing, without client involvement in the technicalities.

While the contracts do not explicitly require R&D activities, CCL retains any intellectual property rights to innovations made during a project and takes on the economic risk of producing such solutions. The terms of agreement with its clients are typically outlined in a letter of intent and formalised in a contract.

CCL claimed R&D tax relief on certain construction project expenses. HMRC rejected the claims and issued closure notices to CCL in respect of its accounting periods ending 30 June 2018 and 2019. The 2018 closure notice rejected a claim for repayment of £573,056.72 and imposed additional tax of £471.99, while the 2019 notice rejected a claim for payment of R&D tax credit of £2,670,972.94. HMRC was of the view that the expenditure was subsidised and the R&D activities were contracted out. CCL was therefore not entitled to the reliefs sought. CCL appealed the closure notices to the FTT.

FTT decision 

The appeal was allowed.

The key issues before the FTT for determination were whether the R&D expenditure was:

1. "subsidised", under section 1138, Corporation Tax Act 2009 (CTA); and
2. incurred in "carrying on activities which are contracted out", under sections 1052 and 1053, CTA.

1. Was the expenditure "subsidised expenditure"?

This issue turned on whether the expenditure was "met directly or indirectly" by another person within the meaning of section 1138(1)(c), CTA.

HMRC argued that CCL's client payments for completed projects indirectly covered the R&D expenditure, which disqualified it from tax relief.

CCL argued that these payments were for specific deliverables, not reimbursement of R&D costs and were based on fixed prices and project scopes, separate from any R&D expenditure.

In the view of the FTT, the expenditure was not subsidised. The contracts were for specified works at an agreed price and not reimbursement for any R&D costs. The contract price did not cover R&D expenses; there was no clear link between client payments and R&D costs. CCL did not expect to be paid for R&D, nor did the client agree to reimburse it for any such expenditure. 

2. Was the expenditure "contracted out"?

If the R&D expenditure qualified as "contracted out", under sections 1052 and 1053, CTA, R&D relief would not be available to CCL. 

HMRC argued that CCL was contractually bound to deliver specific results, including R&D activities, which meant the R&D was effectively contracted out to them as part of fulfilling the client’s requirements. Put simply, had the contract not been in place, CCL would not have incurred the R&D expenditure.

CCL argued that in order for expenditure to be "contracted out" the R&D activities would have to have been required by the terms of the contract, or be within the parties’ reasonable contemplation at the time the contract was entered into and there were no terms within the contract requiring it to undertake R&D activities, nor were R&D activities within the parties’ reasonable contemplation at the time the contract was entered into. The expenses were unplanned, arising from unexpected challenges during projects.

The FTT concluded that the activities were not contracted out. The contracts were for specific works for an agreed price, with no requirement for R&D. The R&D was incidental to the main tasks and carried out at CCL's own risk. There was no provision for reimbursing any R&D costs and CCL retained ownership of the intellectual property created as a result of the R&D it carried out.

Comment

The two issues considered by the FTT in this decision are often raised by HMRC in R&D enquiries and it regularly adopts the positions which it unsuccessfully adopted in this case. The rejection of its arguments in this case by the FTT should cause HMRC to reconsider its approach on both the "subsidised expenditure" and "contracted out" issues. However, given the position HMRC has adopted to date, it may well seek to appeal this decision to the Upper Tribunal.

The decision can be viewed here.