Research Racing for Sailing Gold in 2012

The Sailing element of the Olympic Games, an event in which Team GB won some well deserved medals last year, will be coming to the South Coast in 2012.

As teams across the globe are looking to harness the latest technology (within class rules) to gain those extra few knots, HM Revenue & Customs are starting to look much more critically at claims in the UK for research and development tax relief to determine if the company is eligible for the enhanced tax relief at 175% for its research expenditure, leading to a cash refund from HM Treasury or a significantly reduced corporation tax bill.

It is only now that R&D is becoming better understood by companies, with more claims being submitted each year, no doubt prompting this increased scrutiny.

It is perfectly understandable why companies have not fully understood the available relief. It changes almost every year with the inclusion of a new category of expenditure, to change the definition of qualifying activities or to change the qualifying limits for the different types of relief. It is not just technology companies that can qualify, as many companies in the marine sector are making significant claims for tax rebates.

So what activities qualify?

Broadly, qualifying R&D is characterised by work that breaks new ground for the company, expanding its knowledge or capability, in the process of seeking to resolve a technological uncertainty.

From a practical position the company is best placed to determine if its projects meet the qualifying definition, after all, it is the company that understands what it is trying to achieve and whether the achievement will break new ground.

One specific example we have experienced with HMRC is exactly this issue when the Tax Inspector contested that a new type of propeller did not make an advance over what existed before arguing that the product had been in existence for many years. HMRC eventually agreed that the new design did qualify for enhanced relief after it was explained that, from an engineering perspective, it was intending to significantly improve efficiency.

When considering R&D in the yacht and ship building sectors it is important to consider the whole process, from the computational fluid dynamics work (CFD), through tank testing, up to the first completed hull prototype being sea trialled, as all of these stages will include significant time spent in overcoming technological uncertainties, after all, the CFD work can't solve everything, but it can get you a long way down the river.

What costs will qualify?

The bulk of most R&D claims lies in the labour costs, be this in researching new designs or actually building and sea trialling new hull designs for the first time. In addition to staff costs, expenditure on computer software and consumable/transformable items are also eligible for relief. This will include a fair percentage of heating and power costs for the R&D team.

A proportion of subcontracted activities can also qualify, which could be a significant cost for some marine companies as most would subcontract the CFD and tank testing work, so this part of the project is subcontracted to a university or another company.

How to make the most of the claim?

Qualifying R&D projects vary from developing a more efficient production process (which is often overlooked); through to research capitalising on "blue sky (or sea)" ideas for both brand new products and significant product improvement.

The key issue facing companies is to identify areas of their business that might be eligible for R&D tax relief that are outside of the core research department. For yacht builders, suppliers and parts manufacturers this could relate to new product design and testing, including the cost of making prototypes. Again whilst HMRC are showing particular interest in the costs of prototypes (such as the first boat used for testing and demonstration purposes) significant claims are being made.

Conclusion

Companies must act now to ensure that historic expenditure is not lost. Designs for new hulls, engines, chandlery and other marine supplies are likely to qualify for enhanced tax relief, and it may be possible to surrender any enhanced tax relief for an immediate cash credit from HMRC. By discussing and understanding the finer details of the business process, and applying a detailed interpretation of the DTI guidelines and the tax legislation with a competent advisor, will enable the claim to be submitted in "tax terms" to assist HMRC in understanding the advance being sought. It will also help in identifying the halo team, surrounding the core team directly involved in the R&D project, to ensure a comprehensive claim is made.