Understanding Subsidised and Subcontracted R&D: Key Takeaways from Recent Cases

In November 2024, two significant taxpayer victories in R&D cases occurred within a matter of weeks. HMRC brought both cases (Collins Construction Limited and Stage One Creative Services Limited (SOCS)) to a Tribunal, arguing that the claimed activities had either been subcontracted to the taxpayer by their customers or indirectly subsidised through related revenues. However, in both cases, the judge ruled that the facts did not meet the criteria for subcontracted or subsidised R&D and approved the claims as originally submitted.

Following these eagerly awaited results, Michael Crosson, R&D Technical Senior Consultant at Ryan, examines why these claims reached Tribunal, how the judge’s ruling impacts HMRC’s evolving approach, and what it means for ongoing and future R&D tax relief claims.

Subsidised Expenditure Argument

Before we dissect the Tribunal’s findings, it’s important to ask: What is subsidised R&D? In tax terms, subsidised R&D refers to situations where a company’s R&D expenses are considered to be indirectly or directly funded by an external party—such as a customer—through payments received. This was central to HMRC’s argument in Collins Construction Ltd, but the Tribunal disagreed.

HMRC’s argument in Collins Construction Ltd reflected the same arguments made in a 2021 tribunal case, Quinn (London) Ltd vs Revenue and Customs Commissioners. HMRC claimed that Collins’ customers had indirectly paid the R&D costs because Collins had received payments during the activity. However, Judge Sukul, like Judge Morgan in the Quinn case, found no relationship between the payments from the customer and the R&D costs. The payments were for construction services, not directly for R&D.

These sentiments were echoed in the SOCS case as well. Judge Scott acknowledged that the price of a project could fluctuate over time, sometimes increasing. However, she also pointed out that even if the price changed, it “... might not suffice to cover the costs incurred when fulfilling the contract” – especially unexpected expenses, such as additional R&D efforts. SOCS even incurred losses on one of the three example projects analysed. The R&D project in question required more man-hours for prototyping and testing than had been anticipated, increasing the costs, which were not passed on to the customer. This only reinforces that there was no intrinsic link between the R&D activity and the revenue that SOCS and Collins received, and therefore the costs had not been subsidised.

The rulings from the three cases referenced above suggest that, in industries where pricing and cost structures naturally separate R&D from customer payments – such as construction and engineering – claims are unlikely to be classified as subsidised. However, in sectors like software development, where time is more likely to be billed to customers at an hourly rate, the risk of HMRC viewing costs as subsided is higher.  

Subcontracted Argument

Somewhat surprisingly, the contracted argument received much less explanation in Judge Sukul’s and Judge Scott’s conclusion notes. But first, what is subcontracted R&D? Subcontracted R&D refers to research and development activities performed by one company on behalf of another under a contractual agreement. However, as these cases demonstrate, determining whether R&D is truly subcontracted requires a detailed analysis of things like contractual obligations, ownership of intellectual property, and the intention behind the work.

HMRC argued that Collins Construction Limited’s contractual obligations, including design and construction elements, meant the R&D activity should be deemed contracted to them. This was supported by several specific contract requirements that Collins was obligated to fulfil for their customer, such as the brass cladding to several fire escape doors on one of the sites.

Collins contended that the R&D activities were not explicitly required by the contract and were not anticipated by either party at the time of signing. Therefore, the R&D activity was not contracted to them. This position aligns with HMRC’s historic view on subcontracted activity and its approach to contracted R&D under the merged RDEC and ERIS schemes.

Judge Sukul supported Collins’ position in her decision, using the fire escape doors as an example. Incorporating brass into the doors reduced their fire resilience, and R&D was conducted to improve this resilience whilst maintaining the brass. However, the R&D efforts to achieve this were not contracted to Collins. It wasn’t known that this R&D was needed at the time of the contract, the customer had no technological expertise to understand the issue, and Collins retained the intellectual property generated from the exercise.

Judge Scott took much the same view in her assessment of SOCS’s case. Both judges, Sukul and Scott, carefully reviewed the purpose of the contracted R&D provisions, including preventing market failure because of enhanced reliefs affecting large companies and the more common issue of double claiming. However, Judge Scott stated that since SOCS’s clients didn’t know the details or extent of the R&D activities, they themselves couldn’t claim against them. Further, where SOCS retained the IP generated, there was no argument for their customer being able to claim on the activity.

In both cases, the claimants’ customers couldn’t argue an entitlement to claim themselves. Both judges deemed that the claimants owned the R&D activity. They denied HMRC’s view that the activity had been subcontracted and, therefore, awarded that the claims could remain in full under the SME scheme.

The justifications for the rulings are clear and underpinned by a logic not dissimilar to HMRC’s rules on contracted R&D in the merged RDEC and ERIS schemes.

Merged Scheme – How to Assess Contracted R&D

With the new merged RDEC and ERIS schemes applying from April 2024, HMRC has released new guidance on what makes a project subcontracted. The focus is on determining which company ultimately intended or contemplated the R&D that needed to be undertaken. HMRC says that this can be determined by factors such as:

• Payment dynamics
• Technological understanding
• IP ownership
• Knowledge of the R&D activities required at the outset of the project

While this may sound like a complicated mechanism, they provide plenty of contextual examples, and the logic is consistent throughout.

Looking Ahead: What This Means for UK Businesses

Following the results, HMRC has taken time to consider how to position itself on future claims submitted under the SME and RDEC schemes, as well as live enquiries related to the topic. Their updated guidance, released on 27 February 2025, aligns with the verdicts of Judge Sukul and Scott, as well as the rules for the merged RDEC and ERIS schemes.

While some subjectivity remains, and the industry eagerly awaits their rulings on live enquiries, there is hope for consistency in the enforcement of future claims. This should result in relief going to the right companies and fewer claims being tied up in costly and time-consuming compliance processes.

If you have an enquiry caught up in subsidised or subcontracted arguments, or a project that could be affected by your relationship with an end customer, now is the time to seek expert advice.

If you need support navigating these complexities, our team is here to help. Find out more here about how our team can help you, or contact us today.