Everything qualified, until it did not

A specialist engineering consultancy with about 30 staff was told by a new adviser, after a first meeting with the finance team, that almost all of its project work would qualify. The adviser's fee was 20% of the amount claimed. The claim came to $250,000 on the shared example, built on most of the payroll. Illustrative figures.

A short letter: 20% of the benefit as filed, payable on filing, no cap, review support at hourly rates. The letter did not say how the adviser decided what qualified, and the consultancy did not ask. The engineers were interviewed briefly, as a group, and the technical descriptions were written to a template.

The claim was filed and paid. A review two years later asked the consultancy to show the technical uncertainty in a sample of projects. For most of the sample, the work was skilled application of established methods to client problems: hard, valuable, and not R&D under the test in that country.1Source 1The legal test for qualifying R&D: Internal Revenue Code section 41(d) (United States); Corporation Tax Act 2010 section 1138 and the Guidelines on the meaning of research and development for tax purposes, via HMRC CIRD81300 (United Kingdom); Taxes Consolidation Act 1997 section 766, via Revenue Notes for Guidance Part 29 and Tax and Duty Manual Part 29-02-03 (Ireland); Income Tax Act section 248(1) and CRA, "Guidelines on the eligibility of work for SR&ED tax incentives" (Canada); Income Tax Assessment Act 1997 section 355-25, via Department of Industry, Science and Resources, "Conducting core R&D activities" (Australia); Income Tax Act 2007 section LY 2, via Inland Revenue, "Eligible R&D activities" (New Zealand); Income Tax Act 1947 section 2 and section 14C (Singapore). More detail on your country page. The claim was reduced to $150,000. The consultancy repaid $100,000 with interest where it applied, and a penalty was considered on the basis that reasonable care had not been taken.2Source 2The business repays a reduced claim, with interest and penalties where they apply: IRS, "Interest" and "Accuracy-related penalty" (United States); HMRC, "Tell HMRC if you've claimed too much R&D tax relief" (United Kingdom); Revenue, Tax and Duty Manual Part 29-02-06, "R&D tax credit: clawback of relief" (Ireland); Income Tax Act section 161(1) and CRA, "Avoiding penalties" (Canada); Department of Industry, Science and Resources, "Decisions we make about R&D Tax Incentive applications" (Australia); Inland Revenue, "Interest on overpayments and underpayments" and "Shortfall penalties" (New Zealand); IRAS, "Penalties for errors in tax returns" (Singapore). More detail on your country page. The adviser's fee, charged on the amount claimed, stayed at $50,000, and the help with the review was charged by the hour. Illustrative figures.

A fee of $50,000 on a benefit of $150,000, the repayment of $100,000 with interest, the hourly cost of the review, and the penalty question. A claim built only on the projects that met the test would have been smaller, cheaper and safe. Illustrative figures.

The question how do you decide what qualifies?, and in particular the request for an example of work the adviser would leave out; an adviser who cannot name one has not shown you how the test was applied. The everything qualifies red flag page sets out when a high proportion is a problem and when it is not: a small company whose whole activity is developing one new product may genuinely qualify for most of its work, and this consultancy was not that company. A fee on the amount received, or a refund clause, would have shared the consequence. The green flag that the adviser tells you what does not qualify is the one to look for.

Sources

1. The legal test for qualifying R&D: Internal Revenue Code section 41(d) (United States); Corporation Tax Act 2010 section 1138 and the Guidelines on the meaning of research and development for tax purposes, via HMRC CIRD81300 (United Kingdom); Taxes Consolidation Act 1997 section 766, via Revenue Notes for Guidance Part 29 and Tax and Duty Manual Part 29-02-03 (Ireland); Income Tax Act section 248(1) and CRA, "Guidelines on the eligibility of work for SR&ED tax incentives" (Canada); Income Tax Assessment Act 1997 section 355-25, via Department of Industry, Science and Resources, "Conducting core R&D activities" (Australia); Income Tax Act 2007 section LY 2, via Inland Revenue, "Eligible R&D activities" (New Zealand); Income Tax Act 1947 section 2 and section 14C (Singapore). More detail on your country page.  Back
2. The business repays a reduced claim, with interest and penalties where they apply: IRS, "Interest" and "Accuracy-related penalty" (United States); HMRC, "Tell HMRC if you've claimed too much R&D tax relief" (United Kingdom); Revenue, Tax and Duty Manual Part 29-02-06, "R&D tax credit: clawback of relief" (Ireland); Income Tax Act section 161(1) and CRA, "Avoiding penalties" (Canada); Department of Industry, Science and Resources, "Decisions we make about R&D Tax Incentive applications" (Australia); Inland Revenue, "Interest on overpayments and underpayments" and "Shortfall penalties" (New Zealand); IRAS, "Penalties for errors in tax returns" (Singapore). More detail on your country page.  Back