The First-tier Tribunal has found in favour of construction company Quinn (London) Ltd in its appeal against HMRC’s refusal to allow its claims for enhanced SME R&D relief totalling over £1m. The decision is of importance for all SMEs because HMRC’s interpretation if accepted would have reduced availability of the relief. The position adopted by HMRC in this case appears to be part of an effort to narrow the scope of the relief. The judge did not specify what would amount to an expenditure ‘clear link’ that would make enhanced relief unavailable to SMEs. Further litigation is likely.
On 27 October 2021, Tribunal Judge Harriet Morgan of the First-Tier Tribunal (FTT) handed down her decision in the dispute between construction company Quinn (London) Ltd and HMRC (Quinn (London) Ltd v HMRC (TC/2020/01846)). The FTT found in favour of Quinn, ruling that the company was entitled to enhanced SME research and development (R&D) tax relief totalling over £1m. Tribunal Judge Morgan also found in Quinn’s favour and re-allocated the case to the complex track.
The facts
In summary, during the relevant periods, Quinn carried on the trade of providing construction and refurbishment works to a range of clients in return for an agreed price (which could be varied under certain conditions). During the course of providing construction and refurbishment works for its clients, Quinn developed a number of novel techniques for, inter alia, refurbishment of certain properties.
HMRC accepted that, during the relevant periods, Quinn was a small or medium sized enterprise (SME) and that, in the course of its trade carried on in those periods, Quinn carried out research and development (R&D) and had expended sums on R&D which it was entitled to deduct in computing its taxable profits for the relevant periods for corporation tax purposes (‘the claimed R&D expenditure’). HMRC however refused Quinn’s claims for enhanced R&D relief under CTA 2009 Part 13 Chapter 2 on the basis the claimed R&D expenditure was ‘subsidised’ and amended its tax returns for accounting periods ending 31 May 2017 and 2018 to remove the claims for enhanced R&D relief.
Relevant law
Enhanced R&D relief provides, if available to a qualifying SME, an additional deduction of 130% of the qualifying R&D expenditure against the SME’s otherwise taxable profits (CTA 2009 s 1044(8)).
Various conditions are required to be met in order for an SME to qualify for enhanced R&D relief. The only condition in issue in the case of Quinn was Condition E of s1052(6) of CTA 2009, which provides that in order for the expenditure to qualify for relief it must not be subsidised.
Whether the relevant R&D expenditure is subsidised is determined by consideration of CTA 2009 s 1138. Subsidised expenditure is defined as:
‘(1) For the purposes of this Part a company’s expenditure is treated as subsidised -
(a) if a notified State aid is, or has been, obtained in respect of -
(i) the whole or part of the expenditure, or
(ii) any other expenditure (whenever incurred) attributable to the same research and development project,
(b) to the extent that a grant or subsidy (other than a notified State aid) is obtained in respect of the expenditure,
(c) to the extent that it is otherwise met directly or indirectly by a person other than the company.’
Parties’ arguments
HMRC, in trying to narrow the scope of enhanced R&D relief, relied, inter alia, on the recent FTT decision in Hadee Engineering Co Ltd v HMRC [2020] UKFTT 497 (TC), and it argued that Quinn’s clients indirectly ‘met’ the claimed expenditure by paying Quinn for its services. HMRC submitted that the words ‘directly or indirectly’ cover primarily two scenarios:
If the words ‘directly or indirectly’ in s 1138(1)(c) were not present, it would be very easy, according to HMRC, to circumvent the rules by ensuring the relevant R&D expenditure was paid by the company but then reimbursed by a third party. According to HMRC, Quinn incurred materialist R&D expenditure in the course of providing services to its clients in respect of which it was entitled to payment and was in due course paid. Therefore, HMRC argued that the logical conclusion was that Quinn’s clients ‘indirectly’ met the expenditure by paying Quinn for its services i.e. the second scenario above applied.
Quinn argued that, on the contrary, it cannot be said that the claimed expenditure was ‘met’ by its clients who, under an entirely commercial arrangement, simply paid a price for a product (i.e. the finished building works). Under the same commercial arrangement, Quinn’s obligation was to provide the work in a satisfactory state by an agreed deadline and for an agreed price (which could be varied in certain situations). Ultimately, it was for Quinn to decide how to complete the work and it bore its expenditure in so doing. Its clients were solely interested in the final result and not in Quinn’s costs to fulfil its contractual obligations. Any commercial entity aims to ensure it can recover at least its costs when pitching for and pricing work. That says nothing about what its clients pay for when paying the agreed price. The costs which formed the basis for the enhanced R&D relief claims all fit into the contractual framework and are costs which Quinn incurred in delivering its finished product to its clients. HMRC’s arguments were therefore unworkable if not absurd. The outcome of HMRC’s arguments would lead to almost all expenditure being treated as subsidised (save for companies that are not yet in a position to market the product of its R&D development but will do so and at a later stage recover its costs and make a profit, or are loss making).
The FTT's decision
The FTT held that absent a ‘clear link’ between the price paid by the client/customer and the R&D expenditure, the expenditure could not be said to be subsidised within the meaning of s 1138(1)(c), and enhanced R&D relief should therefore be available. Further, at para 47(1)–(3), the FTT made it clear that s 1138(1)(c) did not broaden the scope of the type of payment which would meet the definition of subsidised expenditure.
Based on the contracts concluded between Quinn and its clients, the clients did not agree to pay or reimburse Quinn for particular costs, such as the claimed R&D expenditure. Further, Quinn did not agree to carry out the relevant R&D on being paid or reimbursed by the clients for doing so. Thus, Quinn’s claims for enhanced R&D relief should be allowed.
According to the FTT, it would be ‘out of kilter with the overall SME scheme, if an SME were to 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.’
Finally, a procedural issue between the parties was whether the case should be re-allocated to the complex track (the case was initially assigned to the standard track). The FTT, again in favour of Quinn, re-allocated the case to the complex track following the Upper Tribunal’s decision in Capital Air Services Ltd v HMRC [2010] UKUT 373 (TCC) (CAS). HMRC having relied on Dreams plc v HMRC [2012] UKFTT 614 (TC) (Dreams) to argue that the circumstances in this case are not such that the Tribunal should exercise its discretion to allocate the case as complex. The judge, disagreeing with the FTT's decision in Dreams, opined that the correct approach to follow in determining whether a case should be allocated as complex in that set out in CAS by the Upper Tribunal.
Wider significance
The FTT’s decision to uphold the appeal against HMRC is important particularly because it prevents a potential narrowing of the scope of the enhanced R&D relief. Though Quinn is a construction business, this decision has significance for SMEs across all industries which incur R&D expenditure. This is so because, as the FTT noted, the case ‘involves an issue on which there is currently no binding authority and the determination of this issue affects the scope of the SME scheme as it may be expected to affect many taxpayers’.
Further, although this case is heavily fact driven, it is nonetheless evident in the authors’ view that HMRC has adopted an approach to interpreting the relevant R&D legislation inconsistent with historic practice and the purpose of the legislation. Enhanced R&D relief was introduced in 2000 with the intent of providing a fiscal incentive to SMEs to incur expenditure on R&D. Under HMRC’s approach, the enhanced R&D relief would have been confined to SMEs that had no prospect of exploiting the R&D for commercial gain or in cases where entities were loss making.
The decision does not provide guidance in respect of how the ‘clear link’ test between the price paid by the client/customer and the expenditure on R&D falls to be considered. Therefore, it is likely that HMRC will continue to dispute claims for enhanced R&D relief and that further litigation may well ensue.
More generally, the appeal is an example in the authors’ view of HMRC seeking to argue for an interpretation inconsistent with the purpose and intent of the legislation, at least as enacted. If it is the case that HMRC wishes to make changes to the availability of the relief, this is a matter for Parliament. On this note, in the Autumn Budget the government has announced reforms to the tax incentives for R&D including changes expanding the types of expenditure that qualify but also stepping up anti-abuse enforcement.
The authors’ firm was instructed to act for Quinn in this case on behalf of and alongside Quinn’s existing advisers ForrestBrown Ltd, a specialist R&D tax relief consultancy .
The First-tier Tribunal has found in favour of construction company Quinn (London) Ltd in its appeal against HMRC’s refusal to allow its claims for enhanced SME R&D relief totalling over £1m. The decision is of importance for all SMEs because HMRC’s interpretation if accepted would have reduced availability of the relief. The position adopted by HMRC in this case appears to be part of an effort to narrow the scope of the relief. The judge did not specify what would amount to an expenditure ‘clear link’ that would make enhanced relief unavailable to SMEs. Further litigation is likely.
On 27 October 2021, Tribunal Judge Harriet Morgan of the First-Tier Tribunal (FTT) handed down her decision in the dispute between construction company Quinn (London) Ltd and HMRC (Quinn (London) Ltd v HMRC (TC/2020/01846)). The FTT found in favour of Quinn, ruling that the company was entitled to enhanced SME research and development (R&D) tax relief totalling over £1m. Tribunal Judge Morgan also found in Quinn’s favour and re-allocated the case to the complex track.
The facts
In summary, during the relevant periods, Quinn carried on the trade of providing construction and refurbishment works to a range of clients in return for an agreed price (which could be varied under certain conditions). During the course of providing construction and refurbishment works for its clients, Quinn developed a number of novel techniques for, inter alia, refurbishment of certain properties.
HMRC accepted that, during the relevant periods, Quinn was a small or medium sized enterprise (SME) and that, in the course of its trade carried on in those periods, Quinn carried out research and development (R&D) and had expended sums on R&D which it was entitled to deduct in computing its taxable profits for the relevant periods for corporation tax purposes (‘the claimed R&D expenditure’). HMRC however refused Quinn’s claims for enhanced R&D relief under CTA 2009 Part 13 Chapter 2 on the basis the claimed R&D expenditure was ‘subsidised’ and amended its tax returns for accounting periods ending 31 May 2017 and 2018 to remove the claims for enhanced R&D relief.
Relevant law
Enhanced R&D relief provides, if available to a qualifying SME, an additional deduction of 130% of the qualifying R&D expenditure against the SME’s otherwise taxable profits (CTA 2009 s 1044(8)).
Various conditions are required to be met in order for an SME to qualify for enhanced R&D relief. The only condition in issue in the case of Quinn was Condition E of s1052(6) of CTA 2009, which provides that in order for the expenditure to qualify for relief it must not be subsidised.
Whether the relevant R&D expenditure is subsidised is determined by consideration of CTA 2009 s 1138. Subsidised expenditure is defined as:
‘(1) For the purposes of this Part a company’s expenditure is treated as subsidised -
(a) if a notified State aid is, or has been, obtained in respect of -
(i) the whole or part of the expenditure, or
(ii) any other expenditure (whenever incurred) attributable to the same research and development project,
(b) to the extent that a grant or subsidy (other than a notified State aid) is obtained in respect of the expenditure,
(c) to the extent that it is otherwise met directly or indirectly by a person other than the company.’
Parties’ arguments
HMRC, in trying to narrow the scope of enhanced R&D relief, relied, inter alia, on the recent FTT decision in Hadee Engineering Co Ltd v HMRC [2020] UKFTT 497 (TC), and it argued that Quinn’s clients indirectly ‘met’ the claimed expenditure by paying Quinn for its services. HMRC submitted that the words ‘directly or indirectly’ cover primarily two scenarios:
If the words ‘directly or indirectly’ in s 1138(1)(c) were not present, it would be very easy, according to HMRC, to circumvent the rules by ensuring the relevant R&D expenditure was paid by the company but then reimbursed by a third party. According to HMRC, Quinn incurred materialist R&D expenditure in the course of providing services to its clients in respect of which it was entitled to payment and was in due course paid. Therefore, HMRC argued that the logical conclusion was that Quinn’s clients ‘indirectly’ met the expenditure by paying Quinn for its services i.e. the second scenario above applied.
Quinn argued that, on the contrary, it cannot be said that the claimed expenditure was ‘met’ by its clients who, under an entirely commercial arrangement, simply paid a price for a product (i.e. the finished building works). Under the same commercial arrangement, Quinn’s obligation was to provide the work in a satisfactory state by an agreed deadline and for an agreed price (which could be varied in certain situations). Ultimately, it was for Quinn to decide how to complete the work and it bore its expenditure in so doing. Its clients were solely interested in the final result and not in Quinn’s costs to fulfil its contractual obligations. Any commercial entity aims to ensure it can recover at least its costs when pitching for and pricing work. That says nothing about what its clients pay for when paying the agreed price. The costs which formed the basis for the enhanced R&D relief claims all fit into the contractual framework and are costs which Quinn incurred in delivering its finished product to its clients. HMRC’s arguments were therefore unworkable if not absurd. The outcome of HMRC’s arguments would lead to almost all expenditure being treated as subsidised (save for companies that are not yet in a position to market the product of its R&D development but will do so and at a later stage recover its costs and make a profit, or are loss making).
The FTT's decision
The FTT held that absent a ‘clear link’ between the price paid by the client/customer and the R&D expenditure, the expenditure could not be said to be subsidised within the meaning of s 1138(1)(c), and enhanced R&D relief should therefore be available. Further, at para 47(1)–(3), the FTT made it clear that s 1138(1)(c) did not broaden the scope of the type of payment which would meet the definition of subsidised expenditure.
Based on the contracts concluded between Quinn and its clients, the clients did not agree to pay or reimburse Quinn for particular costs, such as the claimed R&D expenditure. Further, Quinn did not agree to carry out the relevant R&D on being paid or reimbursed by the clients for doing so. Thus, Quinn’s claims for enhanced R&D relief should be allowed.
According to the FTT, it would be ‘out of kilter with the overall SME scheme, if an SME were to 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.’
Finally, a procedural issue between the parties was whether the case should be re-allocated to the complex track (the case was initially assigned to the standard track). The FTT, again in favour of Quinn, re-allocated the case to the complex track following the Upper Tribunal’s decision in Capital Air Services Ltd v HMRC [2010] UKUT 373 (TCC) (CAS). HMRC having relied on Dreams plc v HMRC [2012] UKFTT 614 (TC) (Dreams) to argue that the circumstances in this case are not such that the Tribunal should exercise its discretion to allocate the case as complex. The judge, disagreeing with the FTT's decision in Dreams, opined that the correct approach to follow in determining whether a case should be allocated as complex in that set out in CAS by the Upper Tribunal.
Wider significance
The FTT’s decision to uphold the appeal against HMRC is important particularly because it prevents a potential narrowing of the scope of the enhanced R&D relief. Though Quinn is a construction business, this decision has significance for SMEs across all industries which incur R&D expenditure. This is so because, as the FTT noted, the case ‘involves an issue on which there is currently no binding authority and the determination of this issue affects the scope of the SME scheme as it may be expected to affect many taxpayers’.
Further, although this case is heavily fact driven, it is nonetheless evident in the authors’ view that HMRC has adopted an approach to interpreting the relevant R&D legislation inconsistent with historic practice and the purpose of the legislation. Enhanced R&D relief was introduced in 2000 with the intent of providing a fiscal incentive to SMEs to incur expenditure on R&D. Under HMRC’s approach, the enhanced R&D relief would have been confined to SMEs that had no prospect of exploiting the R&D for commercial gain or in cases where entities were loss making.
The decision does not provide guidance in respect of how the ‘clear link’ test between the price paid by the client/customer and the expenditure on R&D falls to be considered. Therefore, it is likely that HMRC will continue to dispute claims for enhanced R&D relief and that further litigation may well ensue.
More generally, the appeal is an example in the authors’ view of HMRC seeking to argue for an interpretation inconsistent with the purpose and intent of the legislation, at least as enacted. If it is the case that HMRC wishes to make changes to the availability of the relief, this is a matter for Parliament. On this note, in the Autumn Budget the government has announced reforms to the tax incentives for R&D including changes expanding the types of expenditure that qualify but also stepping up anti-abuse enforcement.
The authors’ firm was instructed to act for Quinn in this case on behalf of and alongside Quinn’s existing advisers ForrestBrown Ltd, a specialist R&D tax relief consultancy .
