CIRD81300 - R&D tax relief: conditions to be satisfied: expenditure must be on an R&D project

Meaning of R&D for tax purposes

In order that expenditure is treated as being on an R&D project, the project must satisfy certain statutory tests in accordance with published guidelines on the meaning of R&D. This is one of the more complex areas of the relief, and it is important to give this matter careful attention.

To arrive at the definition of R&D for the purposes of the legislation we look to ICTA88/S837A. This begins with those activities that are treated as R&D in accordance with GAAP. The relevant UK accounting standard is SSAP13. This is dealt with at CIRD99100. If the company has adopted IAS then the relevant standard is IAS38 and this is dealt with at CIRD99200. We then need to look further to identify the tax rules.

2000 and 2004 DTI guidelines

Section 837A provides for the Secretary of State to issue regulations that modify the qualifying activities. The regulations - which are effected through guidelines - can extend, or restrict, the activities considered to be R&D.

The current (2004) guidelines ( CIRD81900) were issued on 5 March 2004 and came into force for accounting periods ending on or after 1 April 2004. The previous (2000) guidelines ( CIRD81990) are effective for accounting periods ending before that date and were issued on 28 July 2000.

2004 DTI guidelines

The reason for the publication of the 2004 guidelines was to make it easier to identify the relevant tests, thereby reducing the scope for disagreement based on misunderstanding or difficulty in using the old guidelines. The Inland Revenue published a commentary on the 2000 guidelines ( CIRD81995). Because it is specific to the structure of those guidelines it cannot be used to interpret the 2004 guidelines.

Application of the DTI guidelines

The DTI guidelines are themselves based on SSAP13 principles, and while reference to the accountancy guidelines may be useful in understanding a company’s approach, it is preferable to start from the DTI guidelines in deciding whether the subject matter of expenditure is R&D for tax purposes. SSAP13 alone is not adequate for these purposes.

It is important to note that the DTI guidelines provide a definition of R&D for a variety of tax purposes, not just for the purposes of R&D tax relief. And carrying out qualifying R&D is only one part of the relevant tests that need to be satisfied. So even if expenditure qualifies as being on R&D within the guidelines it still needs to meet the conditions in the SME or large company scheme.

There may well be an important difference between a project for the development of a commercial product and an R&D project within the meaning of the legislation. A company with a project to produce a new product will often consider the whole project to be R&D. But this is not necessarily correct for the purposes of R&D tax relief. The R&D project is confined to the parts that directly contribute to the resolution of scientific or technological uncertainty. Other aspects that do not directly contribute to the resolution of scientific and technological uncertainty are not regarded as part of the R&D project.

The fact that there is some technological or scientific uncertainty involved within the project for the development of a new product does not make the whole of that project an R&D project for the purposes of the relief. So, for example, market research to identify the demand for the new product is not part of the R&D. An activity will be R&D if it is carried on in a field of science or technology and is undertaken with a view to the extension of knowledge. A project for the development of a new product, that is not of itself R&D, may contain elements or sub- projects that can be R&D projects for the purposes of the relief. It is those elements or sub- projects undertaken with an aim to extend knowledge to which the relief applies. The sector in which activity is taking place does not change this.

An R&D project can contain a number of sub-projects, but you should look to the largest project in deciding whether expenditure qualifies as directly contributing to it.

The meaning of ‘R&D project’ is dealt with at paragraph 19 of the 2004 DTI guidelines.

Comparison of 2000 and 2004 DTI guidelines

The 2004 DTI guidelines are not considered to restrict or extend the activities that would have qualified as R&D under the 2000 guidelines. The 2004 guidelines are intended to be clearer and simpler to use than the 2000 guidelines; they are clearer and better structured. The 2004 guidelines were introduced following a consultation exercise in 2003. The DTI and the Revenue do not regard the 2004 guidelines as introducing any material changes so we are happy for taxpayers to use them instead of the 2000 guidelines for accounting periods before the 2004 guidelines strictly apply. However, it is possible that companies may take a different view as to the equivalence of the two sets of guidelines and if they wish they could insist on using the 2000 guidelines and our commentary in any accounting periods when they were in force.

Judicial guidance

There is guidance on the meaning of R & D for tax purposes in BE Studios v Smith Williamson Ltd (the case number at the High Court is HC04C0110).

BE Studios had a project to produce new software. Mr. Justice Evans-Lombe accepted that it was not sufficient that the claimant’s products were innovative or cutting edge for them to be R&D within the meaning of the statute. The fundamental test was whether the software work sought to achieve a scientific and or technological advance, and formed the whole or part of a project to resolve scientific and or technological uncertainty on a systematic basis.

On the subject of computer games, he indicated that there were a number of stages in the production of a computer game. These involved conception or acquisition of the ideas for the game, planning, script-writing, drawing and designing backgrounds and characters, creating animated sequences and soundtrack and programming the result of these. He said “none of these activities without more necessarily involve qualifying R&D”.

He was presented with an extensive description of the company’s objectives in terms of new functionality and computer environments, but said that this nowhere described any new scientific or technological knowledge. The judge found that there was no evidence presented that supported the claim that R&D within the DTI guidelines had been carried out.