For years, small and medium-sized enterprises have struggled with uncertainty around what qualifies for R&D tax relief—particularly when innovation is delivered under contract or supported by third-party funding.
The latest updates from HMRC mark a pivotal shift, offering long-awaited clarity on how subcontracted and subsidised activities are treated within the SME R&D scheme. Backed by recent tribunal rulings, this fresh guidance could unlock substantial tax savings for businesses that were previously excluded.
The UK Government's SME R&D scheme has long served as a crucial financial incentive for small and medium-sized enterprises engaged in innovative activities. However, determining eligibility for R&D tax relief has often proven complicated, particularly when work is delivered through contracts or partially funded by third parties.
The latest updates to HMRC’s guidance on subcontracted and subsidised R&D activities offer long-awaited clarity, with recent First-Tier Tribunal cases playing a pivotal role in reshaping how claims should be assessed.
Historically, HMRC treated R&D work performed under a commercial contract with significant caution. If an SME received payment from a customer, HMRC would often assume the R&D was either subcontracted or subsidised—rendering it ineligible under the SME scheme.
This rigid interpretation frequently led to the rejection of legitimate claims, particularly from companies undertaking innovative work as part of broader commercial projects.
However, recent tribunal decisions have brought nuance to this area. In the Collins Construction Limited vs HMRC and Stage One Creative Ltd vs HMRC cases, the courts clarified that merely being paid under a contract does not necessarily mean R&D has been subcontracted. In fact, where the R&D activity is not explicitly required by the contract, or where the client is unaware of the R&D taking place, it may still qualify for tax relief under the SME scheme.
This shift is monumental. It acknowledges the practical realities of how R&D occurs within SMEs—often unexpectedly and reactively in response to project challenges rather than as a pre-defined deliverable. As such, many more companies may now find themselves eligible for tax relief.
One of the most common reasons for the rejection of R&D tax relief claims under the SME scheme has been the classification of work as subcontracted.
According to the traditional guidance, if your business was paid by another party to carry out work, and that work included R&D, the assumption was that the R&D had been subcontracted to you. This typically barred relief under the more generous SME scheme, forcing businesses to claim under the less lucrative RDEC scheme or not at all.
The updated guidance and tribunal decisions challenge this binary view. A key takeaway is that the mere existence of a contract or payment does not automatically equate to subcontracted R&D. What matters is the intent and scope of the contract, and whether the R&D was a requirement or simply arose as part of fulfilling the job.
To be classified as subcontracted, R&D must be explicitly agreed upon between the customer and the contractor. If R&D arises incidentally—for example, due to unforeseen technical challenges—and is not directed or specified by the customer, the SME may still retain eligibility under the SME scheme.
Previously, if you received payment from a third party in relation to a project, HMRC would often conclude that the R&D was "subsidised". Under the SME R&D scheme rules, subsidised R&D is excluded from relief. This led to a wave of rejected claims from SMEs who, despite funding the R&D themselves, were denied relief because they were seen as having received financial support indirectly.
HMRC's new guidance offers a welcome departure from this overly simplistic stance. It now emphasises the need to assess whether payments were specifically intended to fund the R&D activity. In other words, just because you were paid for a contract that involved R&D doesn’t mean the R&D was subsidised.
This distinction is crucial. If the contract payment was for a finished product, solution or service—and not directly earmarked for R&D—the R&D may still be eligible. This interpretation aligns more closely with commercial reality and allows SMEs greater flexibility in structuring their projects while maintaining eligibility for R&D tax relief.
These changes are especially beneficial for contractors and SMEs that regularly undertake technical problem-solving during client engagements. In many cases, R&D is not part of the contract scope but becomes necessary to deliver the final result. Until now, such situations often led to unjust exclusions from the SME scheme.
With the new guidance, if the SME assumes the financial risk of R&D, and the customer neither dictated the R&D nor paid specifically for it, the SME can likely claim under the SME scheme. This opens the door for many businesses that were previously sidelined by rigid interpretations.
Moreover, this change enhances the accessibility of the SME scheme. It acknowledges the fluid, real-world nature of R&D and provides a more equitable framework for recognising genuine innovation.
While HMRC has relaxed certain rules, it has introduced new scrutiny around customer awareness. Specifically, the guidance now considers whether the customer knew R&D was being carried out, and whether any payments made can be construed as funding that R&D.
This introduces a nuanced but critical dimension to claim eligibility. If the customer was aware of the R&D, or if there was any agreement (implicit or explicit) that R&D was to be carried out, HMRC may argue that the R&D was subsidised or subcontracted. In such cases, the SME scheme may not apply.
To protect eligibility, SMEs should carefully review contracts and communications to ensure they do not inadvertently suggest that R&D was expected or funded by the client. Internal documentation and project records should clearly demonstrate that R&D was undertaken independently and at the SME's own risk.
This places a premium on good documentation and clear contractual language. SMEs should work closely with their accountants or tax advisers to ensure they remain compliant under the new framework.
One of the most exciting aspects of this new guidance is the opportunity it offers to revisit old claims. If your business previously had an R&D tax relief claim rejected on the grounds of subcontracting or subsidy, you may now have grounds for reconsideration.
This is particularly relevant if the original decision was based on the assumption that any contractual payment implied subsidy or subcontracting. With HMRC now adopting a more nuanced view, SMEs should review past projects with their advisers to identify claims worth re-submitting.
In some cases, this could result in significant tax savings. Even if the original claim was from several years ago, it may still be eligible depending on the statutory time limits. Given the potential upside, this exercise is well worth the effort.
For SMEs involved in innovation, product development, or custom client projects, the implications of these updates could be substantial. You might find that activities previously considered ineligible due to contractual arrangements or partial funding now fall within the scope of the SME R&D scheme.
Businesses that regularly perform technical problem-solving or develop bespoke solutions for clients should take note. If you're taking on financial risk during projects and investing in untested methods or technologies, you're likely conducting qualifying R&D.
The financial benefit of accessing R&D tax relief can be significant, offering a vital cash injection or reduction in your corporation tax bill. For growing businesses, this can free up funds to reinvest in further innovation or accelerate expansion.
Absolutely. R&D tax relief, particularly under the SME scheme, is a complex area with many nuances. While recent changes have opened the door to more claims, they have also introduced greater scrutiny on aspects like customer awareness and contractual obligations.
Working with an experienced accountant or tax adviser ensures that your claim is correctly structured and well-documented. They can help assess your eligibility, gather and present the right evidence, and avoid common pitfalls that could lead to HMRC queries or claim rejections.
A good adviser will also look at your past claims and spot opportunities to recover relief where earlier interpretations of the rules may have been too strict. In short, the right support can not only boost the value of your claim but also provide peace of mind.
At Pulse Accountants, we specialise in supporting innovative SMEs with tailored R&D tax relief advice. Our team of qualified accountants and tax specialists stay at the forefront of evolving HMRC guidance, so we can interpret changes like these to your advantage.
We take a hands-on approach—working closely with your internal teams to identify eligible R&D activities, drafting robust technical narratives, and ensuring your financial records align with your claims. Our goal is to maximise your claim value while minimising your administrative burden.
We also conduct retrospective reviews of rejected or missed claims. If you think a previous submission may now qualify under the updated SME R&D scheme guidance, we’d be happy to evaluate it with no obligation.
Drop us a message today and we’ll help your business unlock valuable R&D tax relief and take full advantage of the opportunities offered by the latest HMRC updates.