HM Revenue & Customs (HMRC) has today updated its guidance on R&D tax relief, specifically addressing subsidised expenditure (CIRD81650) and subcontracted activities (CIRD84250). These changes were made in response to key tribunal rulings, including Quinn (London) Ltd v HMRC [2021], Collins Construction Ltd v HMRC [2024], and Stage One Creative Services Ltd v HMRC [2024]. These cases challenged HMRC’s restrictive interpretation of when R&D expenditure is considered subsidised or contracted out, leading to a re-examination of HMRC’s approach.
Key Tribunal Rulings
Quinn (London) Ltd v HMRC [2021]: Subsidised Expenditure
The case revolved around Quinn’s claim for SME R&D tax relief on innovative construction techniques. HMRC denied relief, arguing that client payments for the projects indirectly funded the R&D, making it subsidised under CTA 2009, s.1138(1)(c). The tribunal disagreed, ruling that a general commercial contract does not equate to subsidy unless there is a clear and direct link between the payment and the R&D activity. This meant that Quinn’s expenditure was not subsidised since the client was paying for a completed building, not for R&D services.
Collins Construction Ltd v HMRC [2024]: Reaffirming Quinn
Collins Construction faced similar arguments from HMRC, which asserted that the company’s R&D was both subsidised and contracted out. The tribunal upheld Quinn’s logic, concluding that general client payments did not constitute a subsidy and that Collins’ R&D was not contracted out because it was undertaken for its own benefit, not at the client’s specific request. The ruling reinforced the notion that for expenditure to be considered subsidised, it must be explicitly linked to R&D activities, rather than simply occurring as part of a wider commercial engagement.
Stage One Creative Services Ltd v HMRC [2024]: Further Confirmation
Stage One Creative Services (SOCS) was similarly denied relief on the basis that their R&D was both subsidised and contracted out. The tribunal ruled that R&D undertaken independently as part of delivering a contract does not constitute subcontracted work unless the principal explicitly required and paid for R&D. The judge further noted that HMRC’s 2021 guidance had represented a departure from established practice, leading to unfair retrospective assessments.
HMRC’s Updated Guidance vs Tribunal Findings
Subsidised Expenditure (CIRD81650)
Prior to these tribunal rulings, HMRC’s position (from 2021) stated that any payment under a contract was likely to “meet” the R&D costs, effectively treating all commercial transactions as subsidies. This interpretation was directly at odds with Quinn, which emphasised that a payment must be explicitly linked to R&D to be considered a subsidy.
The February 2025 update to CIRD81650 adopts the tribunal’s approach, clarifying that normal business revenue is not considered a subsidy unless the payments are explicitly intended to fund R&D. Examples provided by HMRC now reflect this, acknowledging that a construction firm innovating within a fixed-price contract is not undertaking subsidised R&D.
Contracted-Out R&D (CIRD84250)
Previously, HMRC took an expansive view that if R&D occurred during a contracted project, it was likely to be considered subcontracted work. This was problematic for SMEs, as it broadly disqualified projects where R&D was undertaken as part of fulfilling contractual obligations.
The updated guidance now takes a fact-based approach, asking whether:
- The R&D was incidental to delivering a contract or was explicitly commissioned by the client.
- The company retained financial risk and control over the innovation.
- The client directed or funded specific R&D activities.
This approach aligns with tribunal rulings, ensuring that only R&D explicitly contracted out to an SME is disqualified from SME relief.
The updated CIRDs:
Remaining Areas of Potential Challenge
While the updates align with legal rulings, some areas remain ambiguous:
- Client Awareness of R&D: If a client knows R&D is required but does not formally commission it, HMRC may still attempt to argue the work was contracted out.
- Time and Materials Contracts: While fixed-price contracts have clear rulings, industries using hourly billing models might still face challenges proving the R&D was not contracted out.
- IP Ownership: The tribunal cases noted that SMEs retaining IP or know-how supports the argument that R&D was not outsourced. HMRC’s updated guidance acknowledges but downplays this factor, leaving room for interpretation.
- Retrospective Claims: Companies denied relief under the 2021 guidance may seek amendments for past claims, which HMRC has not addressed.
Conclusion
HMRC’s February 2025 updates largely bring its position in line with tribunal decisions, correcting previous overly broad interpretations. By accepting that subsidised expenditure requires a clear and direct funding link and contracted-out R&D must be explicitly commissioned, HMRC’s guidance now reflects a more accurate and legally sound approach.
While some grey areas remain, these updates provide much-needed clarity, reducing the risk of future disputes. Companies conducting R&D within commercial contracts should ensure they document project ownership, financial risk, and contractual obligations to clearly demonstrate that their R&D is undertaken independently, rather than on behalf of a client.
It is important to realise that the guidance only applies to R&D claims for periods starting before 1st April 2024 where the law changed on contracted out R&D under the new merged RDEC/ERIS laws and the law on subsidised expenditure was removed completely. Clearly as time passes the issues raised in this blog will become historic. But I have two claims where they are front and centre and HMRCs change of stance makes their existing position somewhat untenable.
For expert guidance on how these changes impact your R&D tax claims, contact us at RandDTax.
Christopher Toms MA MAAT
Compliance Director, RandDTax