R&D Tax relief – Good news on the inclusion of production costs for manufacturers

John Moore, August 12th, 2011

HMRC have issued draft guidance on the meaning of production as it relates to the potential for a company to include the cost of manufacturing goods where R&D activity takes place during the manufacture of those goods and then it sells them on to a customer, or intends to.

If you are a manufacturing company undertaking R&D in the process of transferring technology from the ‘bench top’ scale to full scale manufacturing, or involved in the development of working prototypes, or developing ‘first in class assets’ then you are very likely to have had experience of being unable to claim as many of the costs as you knew were required to carry out the relevant R&D activities because of restrictive guidance issued to HMRC staff. We have always argued that this treatment did not represent the commercial reality of the R&D process in manufacturing environments and that a less restrictive approach was required if the schemes were to fully reward the R&D activities undertaken.

New draft guidance shows that HMRC have listened to the concerns of businesses and that they are now proposing to adopt a less restrictive view of qualifying costs. In the past HMRC have taken the line that the exclusion of the production of goods and services in the DTI Guidelines on the meaning of R&D meant that if goods were produced as part of the R&D process and they were intended to be, or actually, sold then their cost could not be included in the claim for R&D tax relief. This was widely held by business not to reflect the commercial realities around launching a new manufactured product and to unfairly exclude activities that otherwise fell within the guidelines.

HMRC now accept that if the main point of the R&D activity is experimentation, contributing to making an advance in science or technology, then there are circumstances where the associated costs can be included in the claim, even if the intention is to sell the output from the R&D activity.

So where production trials are required as part of the process of making a scientific or technological advance then the whole of these costs could qualify for the relief depending on the level of scientific or technological uncertainty existing within the manufacturing process.

‘First in class assets’, which are usually high value and complex items commissioned by customers, where it is not feasible to build a prototype purely for R&D purposes, are almost always destined for sale. The draft guidelines are now saying that R&D projects included within the construction of the first in class assets can be eligible and include qualifying costs. So although the total build costs would not qualify it would be up to the company to demonstrate the qualifying activities within the build process and claim the eligible costs.

HMRC have been trialling this less restrictive approach for months in live claims situations and have now produced the formal draft guidance for further comment.

Action point

If you are a manufacturing company that has had such elements of the R&D process denied in your claims in the past then you need to understand the impact the new guidance could have on any open claims and future claims. We would be happy to discuss this with you in further detail.

Our view

Once again it is welcome news that HMRC have listened to the views of businesses and their advisers and are willing to draft guidance that goes a long way to reflecting the reality of developing a product in a manufacturing environment. There is now an acceptance that it is the fundamental underlying R&D nature of the work that should determine whether or not it is included in an R&D tax relief claim rather than whether it is intended to sell the output at any time in the future. However there are still some refinements that could be made to the guidance in order to further clarify the situation and enable claimants to have more certainty before they claim. We are inputting into this process leading to the publication of the final guidance in due course.


Please do not hesitate to contact John Moore on 0207 292 8850 or at john.moore@kinglybrookesllp.co.uk if you would like to discuss the application of this, or any other aspect of the R&D tax relief to your company.