CIRD81990 - R&D tax relief: conditions to be satisfied: DTI guidelines (2000)
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 Department of Trade and Industry for the purposes of Section 837A Income and Corporation Taxes Act 1988.
Introduction
- 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). R&D is now defined for
tax purposes in Section 837A Income and Corporation Taxes Act 1988.
- S.837B ICTA 1988 defines "oil and gas exploration and
appraisal". The definition of R&D is expressly extended to
include oil and gas exploration and appraisal in certain
situations, in particular for research and development allowances
(the new name for scientific research allowances) in Part VII CAA
1990.
Definition of R&D
- The overarching definition of R&D for tax purposes follows
that used for the purposes of normal accounting practice for UK
companies in Accounting Standard SSAP 13. The definition in SSAP 13
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 SSAP 13 does not include the R&D in the humanities. They do not fall within the fields of science or technology.
- SSAP 13 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 is founded on the
definition of R&D in SSAP 13, but greater certainty is given
through regulations that can prescribe activities that are, or are
not R&D for tax purposes. The regulations may do this by
reference to Guidelines issued by the Secretary of State for Trade
and Industry.
- SSAP 13 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:
- 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;
- 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;
- 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.
- SSAP 13 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.
- SSAP 13 lists various activities which 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.
- 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
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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 will be included.
- It therefore follows that the activities in SSAP 13 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 SSAP 13 listed in paragraph 8 will not be R&D.
R&D Boundaries - Examples
- 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.
- 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.
- 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
- 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 is
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 form the whole or part of a
project to resolve scientific and/or technological uncertainty on a
systematic basis.
- 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.
- 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;
- adaption of existing software;
- preparation of user documentation.
- These do not involve scientific and/or technological advances,
and are not classified as R&D.
- 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 will still qualify as R&D, if the nature of the
application includes a significant degree of novelty.
- 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.
- 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 will qualify.
- 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
- 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
- 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
- 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 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 S.837A ICTA 1988 applies to the
provisions that adopt this definition for chargeable periods ending
on or after 1/4/2000 (corporation tax) and years of assessment
2000/01 onwards (income tax).
"R&D" is expressly extended to include oil and gas
exploration and appraisal (as defined in Section 837B) the purpose
of R&D allowances (the new name for scientific research
allowances) in Part VII Capital Allowances Act 1990. It also
applies to provisions in Section 82A ICTA 1988. 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 S.136(a)
CAA 1990.
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 investment
- R&D tax credits.
Oil & Gas
Oil and gas exploration and appraisal do not qualify as R&D under either SSAP 13 or Frascati, and it is specifically excluded from the general definition of R&D in the new Section 837A ICTA 1988. But oil and gas exploration and appraisal, as defined in new Section 837B ICTA 1988, is expressly brought within the definition of R&D for the purposes of research and development allowances by special provision in Section 139(1)(a) CAA 1990. The eligibility criteria are discussed in more detail in Chapter 3 of the Inland Revenue Oil Taxation Ring Fence CT Manual.
