Carmen Aquerreta is a partner and David Clarke a senior manager in the R&D tax services team at Deloitte. They have assisted a number of clients in delivering substantial cash benefits by maximising their R&D relief claims, particularly in the manufacturing sector.
Maximising cashflow has increasingly been at the heart of many companies’ agendas.
Research & Development (R&D) tax credits are one of the most important funding mechanisms provided by government to encourage innovation in the UK. Since their introduction, the R&D tax relief schemes have supported nearly £52 billion of R&D activity by UK companies.
Identifying what constitutes R&D activity for tax purposes is not always straightforward; the definition is much wider than is often realised. R&D is about resolving challenging technological problems and the relief is available to all industries, not just those traditionally linked to research, such as pharmaceuticals.
Since 2000, companies have been able to claim valuable enhanced tax deductions for staff and consumables costs incurred on R&D projects.
Broadly speaking, R&D takes place where new, or significantly improved, products or processes are being developed, and continues up to the point where the technological uncertainty is resolved. The manufacturing sector is rich in activities that fulfil the R&D tax eligibility criteria driven by the need to introduce new and improved products, meet demanding new regulatory hurdles and customer demands, or improve processes to reduce their environmental impact. Whether developing a product or a manufacturing process, real technological challenges frequently appear, and a process of technical investigation and trials will be required to solve these challenges.
Historically, a contentious issue faced by companies making R&D claims has been to determine where R&D activity ends and production, which does not qualify, begins. After a period of denying that eligible R&D can take place in the production environment, HMRC has recently reviewed their position leading to potential opportunities for organisations involved with manufacturing activity to significantly extend the scope of their claims.
For many, the transfer from lab to full scale production, or the development of working prototypes presents a major technological hurdle within an overall project. Since the introduction of the R&D tax relief, a number of manufacturers have made claims for both the materials and staff costs they have committed to these large scale trial activities.
HMRC had accepted these claims where the end products generated in these trials was not sold, but refused claims where the product was sold, even if at a loss, on the basis this represented ‘production’ and was therefore excluded from the scope of R&D tax relief. Recognising the position was open to interpretation, HMRC issued further guidance at the end of 2009 which prevented claims if any intention to sell the end product generated existed. Frustratingly for many companies, this blocked R&D claims, even where the trials ended in failure and the product generated had to be scrapped.
HMRC recognised this approach was not necessarily identifying the real distinction between production and R&D activities, and realised the end point of R&D would be specific to the nature of the individual trials and each company’s fact pattern.
Recent constructive dialogue with companies to help resolve this issue resulted in HMRC agreeing to review the fact pattern of claims where full scale trials are performed as an integral element of an eligible R&D project, even where the end product generated is sold. This approach, along with emerging common principles, is likely to result in new guidance from HMRC on this matter over the next few months.
So, how does this impact the R&D tax relief potential for manufacturing companies? Well, it opens up new possibilities that did not exist until recently. Regardless of the type of product, or the mode of production (batches or continuous) the many technical challenges faced by manufacturing companies have the potential to drive substantial levels of R&D activity. The costs of both labour and materials associated with scale-up and development activities may now be claimed after appropriate assessment, even where the end product generated by the trials is sold.
