R&D relief for SMEs – a question of intention

01 October 2021

A recent case at the First-Tier Tax Tribunal highlights that the intention behind making an investment is key in determining the eligibility of certain reliefs from aggregating investee companies for the purposes of the SME R&D status test.

It also acts as a further reminder of the level of scrutiny HMRC is currently placing on SME R&D claims, and the importance of having a credible, reliable witness should a case go to the Tribunal.

The case

A research and development company, DNAe Group Holdings Ltd (DNAe), claimed R&D tax relief under the SME scheme for years ending December 2010, 2011 and 2012 for work on DNA gene sequencing. The relief was granted but, in 2017, HMRC launched an enquiry into whether or not DNAe qualified for the SME scheme (much more generous than the Large Company scheme).

HMRC argued that the ownership structure of DNAe meant it should not be treated as an SME for R&D tax relief purposes, and the dispute reached the First-Tier Tax Tribunal (DNAe Group Holdings Limited V HMRC (TC/2018/04348)).

Ownership structure

HMRC’s argument focused on Edith Grove Ltd (EGL) which owned more than 25% of the shares and voting rights of DNAe during the claim periods (but not sufficient to give it direct control of DNAe). EGL was a subsidiary of Genting Berhad Ltd (GBL), and had been set up specifically to allow the group to invest in DNAe. 

Broadly speaking, the relevant law states that a company is part of a group for R&D tax relief purposes if another company has control through ownership of 50% or more of its share capital, voting rights or any other agreement. In many cases this means the group as a whole (counting all its staff, turnover and assets) will breach the capital and staffing thresholds for the claim to qualify for relief under the SME scheme. Where an investor owns between 25% and 50% of a company, only a proportion of its staff and assets are taken into account for these tests, subject to a number of exemptions of which one is the Venture Capital Company exemption. This states that where a venture capital company (ie a company that typically makes speculative or high risk investments in companies with a view to capital appreciation and an exit in 3-5 years) owns between 25% and 50% of a company’s share capital, the investee company is treated as autonomous for the R&D threshold tests.

Where large companies take non-controlling stakes in start-ups, this case provides welcome precedent that, subject to the particular facts and circumstances, the investor company may meet the definition of ‘venture capital company’, thereby allowing the investee company to claim under the more generous SME R&D regime.

This holds true even where the investment has some ‘strategic benefit’ for the wider group, as long as this is not the primary purpose behind the investment.

In this case, the Judge concluded:

In my judgment the primary objective of EGL in investing in DNAe was to make a speculative, high-risk investment with a view to achieving a high return by some form of exit – albeit that the investment was in the area of genomics.

Accordingly, HMRC’s case was dismissed.

Learning points

HMRC’s latest statistics show that it paid out £4.4bn in R&D tax relief on 76,225 claims under the SME scheme for the 2019/20 tax year, so it is perhaps no surprise that it is paying increasing attention to the validity of SME claims, leading to a series of cases going before the courts.

Whether or not HMRC appeals against this ruling to the Upper Tribunal, this case clearly demonstrates the level of detail that HMRC will go into when considering whether or not a company qualifies for SME R&D tax relief (at a higher rate than RDEC).

The case also illustrates that the main intentions of the parties need to be considered when examining the holding structure of the company claiming R&D relief, and the importance of contemporaneous documentation to prove this. In our experience, where there is any subjectivity in the interpretation and application of the law to the claimant company’s situation, it is wise to set out the filing position in a comprehensive R&D report, filed at the same time as the R&D claim is made. This will avoid long-running subsequent disputes with HMRC.

Any company intending to make R&D tax relief claims under the SME scheme should take expert advice on whether its ownership structure will prevent an SME claim, as part of its cost benefit analysis for future research projects.

For historic R&D claims where there are disputes with HMRC over R&D tax relief, it is worth highlighting that there are often routes to resolve these before they escalate to costly Court hearings – read more on Alternative Dispute Resolution.

For help and advice on the R&D SME scheme rules and disputes with HMRC please contact Carrie Rutland or Dawn Register.