CIRD81990 - R&D tax relief: conditions to be satisfied: DTI guidelines (2000): text

For guidance on using these guidelines and information on their status see CIRD81300.

Guidelines on the meaning of R&D for tax purposes

These guidelines are issued by the Secretary of State for the DTI for the purposes of ICTA88/S837A

Introduction

  1. Science is the systematic study of the nature and behaviour of the material and physical universe, and technology is the practical application of science, especially in industry and commerce. The process by which new scientific and technological information is discovered, gathered and used involving theoretical conjecture, observation, experiment, measurement and deduction, is referred to as 'research and development'. R&D is now defined for tax purposes in ICTA88/S837A.

  2. This definition, extended by ICTA88/S837B to include oil and gas exploration and appraisal, replaces the former definition of ‘scientific research’ in CAA90/S139 (1)(a).

Definition of R&D

  1. The overarching definition of R&D for tax purposes follows that used for the purposes of normal accountancy practice for UK companies in Accounting Standard SSAP13. The definition in SSAP13 is itself based on the definition developed by the OECD for the purposes of statistical surveys of R&D (commonly referred to as ‘Frascati’). Frascati defines R&D as comprising "creative work undertaken on a systematic basis in order to increase the stock of knowledge … and the use of this stock of knowledge to devise new applications". But the humanities are excluded because they do not fall within the fields of science or technology.

  2. SSAP13 identifies activities that would normally be, or would not normally be R&D, but the boundary between qualifying and non-qualifying activities is less explicitly defined and open to interpretation. The statutory definition of R&D provides greater certainty by imposing a second test for the purposes of the tax legislation. To qualify as R&D, the activity must not only be R&D as defined by SSAP13, but it must also satisfy the conditions set out in these guidelines, which are issued for tax purposes by the Secretary of State.

  3. SSAP13 defines R&D in terms of research and development. Research is further divided into pure (or basic) and applied research. Thus, R&D covers the following related activities:
  1. pure (or basic) research: Experimental or theoretical work undertaken primarily to acquire new scientific or technical knowledge for its own sake rather than directed towards any specific aim or application;

  2. applied research: Original or critical investigation undertaken in order to gain a new scientific or technical knowledge and directed towards a specific practical aim or objective;

  3. development: Use of scientific or technical knowledge in order to produce new or substantially improved materials, devices, products or services, to install new processes or systems prior to the commencement of commercial production or commercial applications, or to improving substantially those already produced or installed.
  1. SSAP13 distinguishes R&D activity from non-research activity by the presence or absence of an appreciable element of innovation. If the activity departs from routine and breaks new ground it should normally be included; if it follows an established pattern it should normally be excluded.

  2. SSAP13 lists various activities that would normally be included in R&D:
  • experimental, theoretical or other work aimed at the discovery of new knowledge, or the advancement of existing knowledge;
  • searching for applications of that knowledge;
  • formulation and design of possible applications for such work;
  • testing in search for, or evaluation of, product, service or process alternatives;
  • design, construction and testing of pre-production prototypes and models and development batches;
  • design of products, processes, services or systems involving new technology or substantially improving those already produced or installed;
  • construction and operation of prototypes and pilot plants.
  1. SSAP13 lists various activities that would normally be excluded from R&D:
  • testing analysis either of equipment or product for the purposes of quality or quantity control;
  • periodic alterations to existing products, services or processes even though these may represent some improvement;
  • operational research not tied to specific research and development activity;
  • cost of corrective action in connection with break-downs during commercial production;
  • legal and administrative work in connection with patent applications, records and litigation and the sale or licensing of patents;
  • activity, including design and construction engineering, relating to the construction, relocation, rearrangement or start-up of facilities or equipment other than facilities or equipment whose sole use is for a particular research and development project;
  • market research.

The Boundary of R&D and Other Related Activities

  1. Identifying the boundary between R&D and non-R&D activities can sometimes pose practical difficulties. But an activity will be R&D if carried on in the field of science or technology and undertaken with a view to the extension of knowledge.

  2. R&D is thus characterised by work which breaks new ground and the novelty of what is being created in an atmosphere of scientific or technological uncertainty, and if successful will result in the extension of scientific or technical knowledge (although it is recognised that R&D will not always be successful). R&D should be founded on the investigation and exploitation of a scientific principle. This may be in pursuit of the creation or development of, for example, new liquids, substances, materials, software, designs, products, processes, technology or knowledge. R&D may result in intangible as well as tangible outputs.

  3. Within this context, activities will be R&D if they consist of:
  • the application of new scientific or technological principles in an existing area of investigation; or
  • the application of existing scientific or technological principles in a new area of investigation.
  1. Care must be taken to distinguish R&D from other activities that may be part of the wider innovation process. R&D will not include activities based upon the use of well- established products or processes, which may be new to the user but do not represent any departure from common knowledge or practice for the industry sector concerned. Neither will R&D include any activity that is not intended to lead to a scientific or technical advance or which did not break new ground intended to lead to substantial improvement for the business's products, processes or services.

  2. Experimental development falls within R&D, but commercial development, including pre-production development and product development is outside R&D. There may still be difficulties in distinguishing these activities. The basic rule is to look at the primary objective of the work undertaken. If the primary objective of the development is to test the viability of the R&D, or to make further technical improvements on the product or process, then the work comes within the definition of R&D (subject to the basic requirement that R&D has to include an appreciable element of novelty). On the other hand, further development is not R&D if the product, process or approach is substantially set, or the technological uncertainty has been resolved, even though the development may be related to the design or bringing on of a product. Similarly, pre- production planning, or work to get a production or control system working smoothly is not R&D. Thus, R&D would include novel work which draws on or creates a new source of knowledge which might lead to the breaking of new ground or a technical advance and which might subsequently entail the creation or development of a new or substantially improved product, process or service.

  3. This means that work on the periodic updating or modification of a product will not be R&D if it does not involve an appreciable element of innovation and does not break new ground. However, a programme of R&D may result in incremental improvements to a product, service or process.

  4. The commercial development of a product may start before all the technical uncertainties have been resolved. In this situation, although activities directed towards commercial exploitation will not be R&D, related activities carried on primarily to resolve continuing technological uncertainties would still count as R&D if they contain an appreciable element of novelty. Similarly, new technical problems may emerge after a new product or process has been turned over to production, and the resolution of these problems may require new R&D to be carried out. However, the detection of faults in, or the modification of equipment or processes will normally involve minor modifications of standard equipment or processes and this will not be R&D.

  5. Normally research in the humanities and social sciences is excluded. But it is recognised that some aspects of the fields of natural or applied science require consideration be given to the humanities, for example the development of effective man-machine interfaces in virtual reality, or ergonomic considerations for new forms of communications. Where such research forms an integral part of the natural or applied R&D it may be included.

  6. It therefore follows that the activities in SSAP13 listed in paragraph 7 above will be R&D if they are carried on as, or as part of a scientific or technological investigation, or as pre-production development, to break new ground and increase knowledge or resolve technological uncertainty. Similarly, the activities from SSAP13 listed in paragraph 8 will not be R&D.

R&D Boundaries - Examples

  1. The boundaries of R&D are illustrated by the following examples. They are not intended to be exhaustive.
  • In medicine, routine testing (such as body scanning, autopsies or blood tests) is not R&D. But a special investigation to determine the effectiveness of a certain type of cancer treatment that requires, for example, certain tests to generate a data set for the programme of research would be R&D.
  • For physical phenomena, routine monitoring such as daily records of temperature and pressure variation or quality control on material composition and properties is not R&D. But a programme of work to investigate the effects of climate change, to devise new or substantially improved methods or instruments for measuring temperature and pressure, or for developing new materials and evaluating their properties all of which require the collation and analysis of data would be R&D.
  • In engineering disciplines, R&D generally includes the development of a piece of fundamental research up to the start of the production stage. This may include incremental developments where they arise from a programme of research designed to result in substantial improvement. For example, design, drawing and operating instructions for the setting up and operation of pilot plant and prototypes primarily to test R&D hypotheses would constitute R&D. However, design and drawing work for the preparation, execution and maintenance of production standardisation (e.g. jigs and tools), or to promote the sale of products would not constitute R&D.
  1. The treatment of prototypes and pilot plant can illustrate the boundary between experimental development R&D and pre-production work. A prototype is an original model constructed to have all of the technical characteristics of the anticipated new product. The design, construction and testing of prototypes would fall within R&D where this falls at the end of an R&D investigation. But once any modifications necessary to reflect the test findings have been made to the prototypes and further testing satisfactorily completed, the R&D phase has been completed and pre- production has begun.

  2. Similarly, pilot plant constructed to evaluate R&D hypotheses, develop new product formulae, establish new product specifications, design special equipment and structures and prepare operating instructions or manuals on the process will fall within the R&D activity.

Software

  1. Software may qualify in two respects (i) as the object of the R&D and (ii) as the means to achieve the R&D. Software should be given equal treatment to other forms of technological activity. That is to say, for a project to be classified under case (i) as 'a software R&D project' it must seek to achieve a scientific and/or technological advance, and the whole or part of a project to resolve scientific and/or technological uncertainty on a systematic basis.

  2. Software R&D might include investigations in such areas as theoretical computer science, new operating systems, new programming languages, significant technical advances in algorithms, new or enhanced query languages, or object representations, software engineering methodologies for improved computer programmes and artificial intelligence. In this context, artificial intelligence might cover technical advances in such areas as machine vision, robotics, expert systems, neural networks, the understanding of natural language and automatic language translation. The development of, say, a new natural language interface for a computer game could qualify as R&D, although the game may be a mature product and represent non-R&D activity in most other respects.

  3. Even so, software-related activities of a routine nature are not considered to be R&D. Such activities include work on system-specific or programme-specific advancements, which were publicly available prior to the commencement of the work. Technical problems, which have been overcome in previous projects on the same operating systems and computer architecture, are excluded as are activities such as:
  • supporting existing systems;
  • converting/and or translating computer languages;
  • adding user functionality to application programmes;
  • de-bugging of systems;
  • adaptation of existing software;
  • preparation of user documentation.
  1. These do not involve scientific and/or technological advances, and are not classified as R&D.

  2. Software based, case (ii) projects involve the development or use of software within a larger R&D project. There may be no technical advance to the software per se, but the software element of the project may still qualify as R&D, if the nature of the application includes a significant degree of novelty.

  3. For example, a project to develop a new product using virtual reality simulation and computer aided engineering is most likely to use an existing computer aided engineering (CAE) package and simulation software. This would not constitute an advance to the software. However, experimental development directed towards producing a new product/process or a substantial improvement to an existing product/process aided by such computer software may still constitute R&D.

  4. Software based R&D activities of this kind will be wide ranging. They may, for example, entail experimentation in the design of new drugs, or the development of novel aerospace concepts. The use of existing computer software and finite element analysis to simulate say the aerodynamics or fluid dynamics and strength of a new vehicle, aerofoil or structure is unlikely to involve software R&D. However, the underlying research, design and development programme in these areas involving theoretical simulation, experimentation and the correlation of one with the other could.

  5. Software development intended for the analysis of, for example, market research data, which was not expected to result in the development of a scientific advance to the software, such as a new algorithm, would not be considered R&D.

Qualifying Indirect Activities

  1. Supporting activities that will qualify if part of a larger R&D project are:
  • scientific and technical information services, insofar as they are conducted for the purpose of R&D support (such as the preparation of the original report of R&D findings);
  • indirect supporting activities such as maintenance, security, administration and clerical activities, and finance and personnel activities, insofar as undertaken for R&D;
  • certain ancillary activities essential to the undertaking of qualifying R&D (e.g. taking on and paying staff, leasing laboratories and maintaining research and development equipment including computers used for R&D purposes);
  • training required to directly support an R&D project;
  • research by students and researchers carried out at universities;
  • research (including related data collection) to devise new scientific or technological testing methods, survey methods or sampling methodologies;
  • feasibility studies to inform the strategic direction of a specific R&D activity.

Exclusions from R&D

  1. R&D must be distinguished from a wide range of related activities. In addition to the activities listed in paragraph 8 above, the following are examples of activities that would be excluded from R&D, except insofar as they have been specifically included as potentially qualifying indirect activities at paragraph 29:
  • general education and training;
  • scientific and technical information services;
  • general purpose data collection;
  • calibration of standards and routing testing and analysis of materials, components, products and processes;
  • the acquisition of rights in, or arising from, R&D;
  • routine computer maintenance or software development;
  • specialised (routine) medical care;
  • policy studies.

Other General Exclusions

  1. A major source of difficulty in classifying work as R&D occurs at the interface between genuine R&D and activities related to the innovation process. General commercial activities will not normally be R&D. These include:
  • the range of commercial and financial steps necessary for innovation and the successful development and marketing of a new product, process or service;
  • the production and distribution of goods and services;
  • administration and other supporting services not directly related to the R&D activity;
  • general support services (such as transportation, storage, cleaning, repair, maintenance and security) not directly related to the R&D activity.

Notes (not forming part of the guidelines)

Application of the Definition of R&D

The definition of R&D in ICTA88/S837A applies to chargeable periods ending on or after 1 April 2000 (corporation tax) and years of assessment 2000-01 onwards (income tax). The definition, extended to include oil and gas exploration and appraisal, applies for the purpose of R&D capital allowances (scientific research allowances) in Part VII Capital Allowances Act 1990. It also applies to provisions in ICTA88/S82A. These permit a revenue deduction for expenditure on R&D related to the trade of the person incurring it that would not otherwise be allowed for tax purposes. These provisions were formerly contained in CAA90/S136 (a). The definition of research and development, but without the extension for oil and gas exploration and appraisal, also applies to the following provisions:

  • Enterprise Investment Scheme, in relation to shares issued on or after 6 April 2000,
  • Venture Capital Trusts, in relation to shares or securities issued on or after 6 April 2000,
  • Corporate Venturing Scheme,
  • Enterprise Management Initiative,
  • R&D tax credits,
  • oil & gas.

Oil and gas exploration and appraisal do not qualify as R&D under either SSAP13 or Frascati, and it is specifically excluded from the general definition of R&D in the new ICTA88/S837A. But oil and gas exploration and appraisal, as defined in new ICTA88/S837B, is included within the definition of R&D for the purposes of research and development capital allowances by special provision in CAA01/S437 (1)(b). The eligibility criteria are discussed in more detail in paragraph 26000 of the Oil Taxation Manual.

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