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The tax definition of R&D

The tax definition of R&D is that R&D takes place when a project seeks to achieve an advance in science or technology. The advance must be an advance in overall knowledge or capability in a field of science or technology as opposed to a company`s own state of science or technology.

The requirement for an overall scientific or technological advance has existed since the U.K. R&D tax relief schemes were incepted. Whilst the definition of “science” has been extended to include mathematical advances, the core tax definition of requiring an advance in science or technology has always been the same.

Dilution of the tax definition of R&D

It is well documented that R&D tax relief has developed a reputation, in recent years, of being an easy relief for companies to claim because the majority of claims submissions are paid out without scrutiny from HMRC. Like bees to a honey pot, the lack of claims scrutiny led to the growth of an industry of R&D tax relief experts wanting to cash in on R&D tax relief.

Disproportionately high contingency fees have resulted in the growth of an industry of R&D tax relief specialists who vary massively in their skill and expertise and regrettably, the threshold in terms of the type of activity that is understood to qualify as “R&D” has been lowered and the tax definition has become diluted over time. HMRC accepting poor quality claims through lack of claims scrutiny has, also, contributed to the lowering of the threshold with many companies and their advisors becoming lulled into thinking that projects involving any kind of technical problem-solving qualify without considering whether the strict tax definition is met or the type of innovation that the Government wanted to support when introducing R&D tax relief in the first place.

It is no surprise that the number of R&D claims submissions has increased dramatically over the years. Statistics released by HMRC show that in the tax year 2015/2016 almost 45,000 claims were made but for the the tax year 2020/2021, this number had increased to over 90,000 claims.

Government concerns about the increased number of claims, quality, error and potential fraud has led to a significantly increased number of claims now enquired into by HMRC. HMRC figures for the year 2020/2021 state that the level of error and fraud stands at 16.7%, equivalent to £1.13billion.

Whilst there is widespread criticism of HMRC`s current R&D tax relief enquiry regime- of tax inspectors failing to understand and apply the Department of Science, Innovation & Technology guidelines to claims correctly; refusing to accept a company`s competent professionals as appropriately qualified to comment on R&D evidence or failing to accept the assertions of a competent professional, instead preferring to rely on a Google search – it is clear that to qualify for R&D tax relief, HMRC is imposing a higher threshold and evidential burden for proving that the project aimed to advance science or technology than most taxpayers and R&D specialists assumed was historically required and this is proving a problem for some.

Relationship between R&D and patenting

It is not currently a HMRC condition that for a company to be able to claim R&D tax relief, it must apply for patent protection over the invention/ the outcome of the R&D activity. It used to be a condition to claim that the taxpayer owned the intellectual property arising from the R&D activity, but this is no longer the case.

Whilst this is so, the issue of patent protection and whether a company has taken steps to apply for a patent is a question that companies frequently have to answer during an HMRC enquiry.

HMRC`s inference seems to be “If the invention was so innovative (and important to the overall field of science or technology), why did you not take steps to protect it?”

The answer has normally more to do with the commercial reality of patenting rather than whether the invention was sufficiently inventive to benefit from patenting. Many companies are deterred from patenting due to cost or the sense that determined IP infringers will circumvent the patent and copy the invention regardless of the protection if they want to do so.

The similarities between the tax definition of R&D and the legal requirements for patenting

Many people are unaware that there are key similarities between the tax definition of R&D and the legal requirements for patenting an invention in the U.K. Recognition of the similarities may encourage companies who are eligible to claim R&D tax relief to consider patenting the outcome of the R&D activity if they had not considered patenting already and conversely, companies who have been advised that their invention is patentable but they have not considered claiming R&D tax relief, may consider making a claim.

As stated above, the tax definition of R&D is that R&D takes place in a project that aims to advance overall science or technology. The requirement for an overall advance means going beyond established scientific or technical knowledge and capability and to successfully claim the relief, companies must be able to demonstrate the baseline position in the relevant field, in order to show advancement.

The legal requirements for patenting are similar and require the invention to be new/novel, the invention to involve an inventive step and the invention to be capable of industrial application.

An invention is new if it does not form part of the state of the art meaning that it is not already available within the public domain, within the U.K. or anywhere else. An invention is inventive if it is not obvious to a person skilled in the art, having regard to any matter which forms part of the state of the art.

The similarities between the requirement to prove an advance in overall science and technology in claiming R&D tax relief and the requirement to prove that an invention is new and involves an inventive step when patenting is obvious.

As such, if advice has been sought from a patent attorney to say that an invention is patentable or if a patent application has actually been filed; this should help a company`s claim for R&D tax relief to be viewed in a favourable light by HMRC in terms of whether the tax definition of R&D has been satisfied. In my view, it would be very difficult for HMRC to argue that science/technology had not been advanced in the case of an invention which is patentable.

Given the current barriers to obtaining a successful R&D claim, one wonders whether this is the answer in difficult cases where HMRC will not accept that a scientific/technical advancement has been attempted; to obtain the opinion of a patent attorney in terms of patentability. Certainly, it would stop the current practice of HMRC carrying out Google searches rather than listen to the opinion of a company`s competent professional and would potentially also then provide the company with a patented asset.

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