May
2001
GUIDELINES
ON THE MEANING OF RESEARCH AND DEVELOPMENT (R&D) FOR TAX PURPOSES
These
Guidelines are issued by the Secretary of State for the Department
of Trade and Industry for the purposes of Section 837A Income
and Corporation Taxes Act 1988.
Introduction
1.
Science is the systematic study of the nature and behaviour of
the material and physical universe, and technology is the practical
application of science, especially in industry and commerce. The
process by which new scientific and technological information
is discovered, gathered and used involving theoretical conjecture,
observation, experiment, measurement and deduction, is referred
to as 'research and development' (R&D). R&D is now defined for
tax purposes in Section 837A Income and Corporation Taxes Act
1988.
2.
This definition, extended by S.837B ICTA 1988 to include oil and
gas exploration and appraisal, replaces the former definition
of "scientific research" in S.139(1)(a) CAA 1990.
Definition
of R&D
3.
The overarching definition of R&D for tax purposes follows that
used for the purposes of normal accountancy practice for UK companies
in Accounting Standard SSAP 13. The definition in SSAP 13 is itself
based on the definition developed by the OECD for the purposes
of statistical surveys of R&D (commonly referred to as "Frascati").
Frascati defines R&D as comprising "creative work undertaken
on a systematic basis in order to increase the stock of knowledge
… and the use of this stock of knowledge to devise new applications".
But the humanities are excluded because they do not fall within
the fields of science or technology.
4.
SSAP 13 identifies activities that would normally be, or would
not normally be R&D, but the boundary between qualifying and non-qualifying
activities is less explicitly defined and open to interpretation.
The statutory definition of R&D provides greater certainty by
imposing a second test for the purposes of the tax legislation.
To qualify as R&D, the activity must not only be R&D as defined
by SSAP 13, but it must also satisfy the conditions set out in
these Guidelines, which are issued for tax purposes by the Secretary
of State.
5.
SSAP 13 defines R&D in terms of research and development. Research
is further divided into pure (or basic) and applied research.
Thus, R&D covers the following related activities:
a.
pure (or basic) research: Experimental or theoretical work
undertaken primarily to acquire new scientific or technical knowledge
for its own sake rather than directed towards any specific aim
or application;
b.
applied research: Original or critical investigation undertaken
in order to gain a new scientific or technical knowledge and directed
towards a specific practical aim or objective;
c.
development: Use of scientific or technical knowledge in
order to produce new or substantially improved materials, devices,
products or services, to install new processes or systems prior
to the commencement of commercial production or commercial applications,
or to improving substantially those already produced or installed.
6.
SSAP 13 distinguishes R&D activity from non-research activity
by the presence or absence of an appreciable element of innovation.
If the activity departs from routine and breaks new ground it
should normally be included; if it follows an established pattern
it should normally be excluded.
7.
SSAP 13 lists various activities which would normally be included
in R&D:
- experimental,
theoretical or other work aimed at the discovery of new knowledge,
or the advancement of existing knowledge;
- searching
for applications of that knowledge;
- formulation
and design of possible applications for such work;
- testing
in search for, or evaluation of, product, service or process
alternatives;
- design,
construction and testing of pre-production prototypes and models
and development batches;
- design
of products, processes, services or systems involving new technology
or substantially improving those already produced or installed;
- construction
and operation of prototypes and pilot plants.
8.
SSAP13 lists various activities that would normally be excluded
from R&D:
- testing
analysis either of equipment or product for the purposes of
quality or quantity control;
- periodic
alterations to existing products, services or processes even
though these may represent some improvement;
- operational
research not tied to specific research and development activity;
- cost of
corrective action in connection with break-downs during commercial
production;
- legal
and administrative work in connection with patent applications,
records and litigation and the sale or licensing of patents;
- activity,
including design and construction engineering, relating to the
construction, relocation, rearrangement or start-up of facilities
or equipment other than facilities or equipment whose sole use
is for a particular research and development project;
- market
research.
The
Boundary of R&D and Other Related Activities
9.
Identifying the boundary between R&D and non-R&D activities can
sometimes pose practical difficulties. But an activity will be
R&D if carried on in the field of science or technology and undertaken
with a view to the extension of knowledge.
10.
R&D is thus characterised by work which breaks new ground and
the novelty of what is being created in an atmosphere of scientific
or technological uncertainty, and if successful will result in
the extension of scientific or technical knowledge (although it
is recognised that R&D will not always be succesful). R&D should
be founded on the investigation and exploitation of a scientific
principle. This may be in pursuit of the creation or development
of, for example, new liquids, substances, materials, software,
designs, products, processes, technology or knowledge. R&D may
result in intangible as well as tangible outputs.
11.
Within this context, activities will be R&D if they consist of:
- the application
of new scientific or technological principles in an existing
area of investigation; or
- the application
of existing scientific or technological principles in a new
area of investigation.
12.
Care must be taken to distinguish R&D from other activities that
may be part of the wider innovation process. R&D will not include
activities based upon the use of well-established products or
processes, which may be new to the user but do not represent any
departure from common knowledge or practice for the industry sector
concerned. Neither will R&D include any activity that is not intended
to lead to a scientific or technical advance or which did not
break new ground intended to lead to substantial improvement for
the business's products, processes or services.
13.
Experimental development falls within R&D, but commercial development,
including pre-production development and product development is
outside R&D. There may still be difficulties in distinguishing
these activities. The basic rule is to look at the primary objective
of the work undertaken. If the primary objective of the development
is to test the viability of the R&D, or to make further technical
improvements on the product or process, then the work comes within
the definition of R&D (subject to the basic requirement that R&D
has to include an appreciable element of novelty). On the other
hand, further development is not R&D if the product, process or
approach is substantially set, or the technological uncertainty
has been resolved, even though the development may be related
to the design or bringing on of a product. Similarly, pre-production
planning, or work to get a production or control system working
smoothly is not R&D. Thus, R&D would include novel work which
draws on or creates a new source of knowledge which might lead
to the breaking of new ground or a technical advance and which
might subsequently entail the creation or development of a new
or substantially improved product, process or service.
14.
This means that work on the periodic updating or modification
of a product will not be R&D if it does not involve an appreciable
element of innovation and does not break new ground. However,
a programme of R&D may result in incremental improvements to a
product, service or process.
15.
The commercial development of a product may start before all the
technical uncertainties have been resolved. In this situation,
although activities directed towards commercial exploitation will
not be R&D, related activities carried on primarily to resolve
continuing technological uncertainties would still count as R&D
if they contain an appreciable element of novelty. Similarly,
new technical problems may emerge after a new product or process
has been turned over to production, and the resolution of these
problems may require new R&D to be carried out. However, the detection
of faults in, or the modification of equipment or processes will
normally involve minor modifications of standard equipment or
processes and this will not be R&D.
16.
Normally research in the humanities and social sciences is excluded.
But it is recognised that some aspects of the fields of natural
or applied science require consideration be given to the humanities,
for example the development of effective man-machine interfaces
in virtual reality, or ergonomic considerations for new forms
of communications. Where such research forms an integral part
of the natural or applied R&D it may be included.
17.
It therefore follows that the activities in SSAP 13 listed in
paragraph 7 above will be R&D if they are carried on as, or as
part of a scientific or technological investigation, or as pre-production
development, to break new ground and increase knowledge or resolve
technological uncertainty. Similarly, the activities from SSAP
13 listed in paragraph 8 will not be R&D.
R&D
Boundaries - Examples
18.
The boundaries of R&D are illustrated by the following examples.
They are not intended to be exhaustive.
- In
medicine, routine testing (such as body scanning, autopsies
or blood tests) is not R&D. But a special investigation to determine
the effectiveness of a certain type of cancer treatment that
requires, for example, certain tests to generate a data set
for the programme of research would be R&D.
- For
physical phenomena, routine monitoring such as daily records
of temperature and pressure variation or quality control on
material composition and properties is not R&D. But a programme
of work to investigate the effects of climate change, to devise
new or substantially improved methods or instruments for measuring
temperature and pressure, or for developing new materials and
evaluating their properties all of which require the collation
and analysis of data would be R&D.
- In engineering
disciplines, R&D generally includes the development of a
piece of fundamental research up to the start of the production
stage. This may include incremental developments where they
arise from a programme of research designed to result in substantial
improvement. For example, design, drawing and operating instructions
for the setting up and operation of pilot plant and prototypes
primarily to test R&D hypotheses would constitute R&D. However,
design and drawing work for the preparation, execution and maintenance
of production standardisation (e.g jigs and tools), or to promote
the sale of products would not constitute R&D.
19.
The treatment of prototypes and pilot plant can
illustrate the boundary between experimental development R&D and
pre-production work. A prototype is an original model constructed
to have all of the technical characteristics of the anticipated
new product. The design, construction and testing of prototypes
would fall within R&D where this falls at the end of an R&D investigation.
But once any modifications necessary to reflect the test findings
have been made to the prototypes and further testing satisfactorily
completed, the R&D phase has been completed and pre-production
has begun.
20.
Similarly, pilot plant constructed to evaluate R&D hypotheses,
develop new product formulae, establish new product specifications,
design special equipment and structures and prepare operating
instructions or manuals on the process will fall within the R&D
activity.
Software
21.
Software may qualify in two respects (i) as the object of the
R&D and (ii) as the means to achieve the R&D. Software should
be given equal treatment to other forms of technological activity.
That is to say, for a project to be classified under case (i)
as 'a software R&D project' it must seek to achieve a scientific
and/or technological advance, and the whole or part of a project
to resolve scientific and/or technological uncertainty on a systematic
basis.
22.
Software R&D might include investigations in such areas
as theoretical computer science, new operating systems, new programming
languages, significant technical advances in algorithms, new or
enhanced query languages, or object representations, software
engineering methodologies for improved computer programmes and
artificial intelligence. In this context, artificial intelligence
might cover technical advances in such areas as machine vision,
robotics, expert systems, neural networks, the understanding of
natural language and automatic language translation. The development
of, say, a new natural language interface for a computer game
could qualify as R&D, although the game may be a mature product
and represent non-R&D activity in most other respects.
23.
Even so, software-related activities of a routine nature are not
considered to be R&D. Such activities include work on system-specific
or programme-specific advancements which were publicly available
prior to the commencement of the work. Technical problems which
have been overcome in previous projects on the same operating
systems and computer architecture are excluded as are activities
such as:
- supporting
existing systems;
- converting/and
or translating computer languages;
- adding
user functionality to application programmes;
- de-bugging
of systems;
- adaptation
of existing software;
- preparation
of user documentation.
24. These
do not involve scientific and/or technological advances, and are
not classified as R&D.
25. Software
based, case (ii) projects involve the development or use of
software within a larger R&D project. There may be no technical
advance to the software per se, but the software element of the
project may still qualify as R&D, if the nature of the application
includes a significant degree of novelty.
26. For example,
a project to develop a new product using virtual reality simulation
and computer aided engineering is most likely to use an existing
computer aided engineering (CAE) package and simulation software.
This would not constitute an advance to the software. However,
experimental development directed towards producing a new product/process
or a substantial improvement to an existing product/process aided
by such computer software may still constitute R&D.
27. Software
based R&D activities of this kind will be wide ranging. They may,
for example, entail experimentation in the design of new drugs,
or the development of novel aerospace concepts. The use of existing
computer software and finite element analysis to simulate say
the aerodynamics or fluid dynamics and strength of a new vehicle,
aerofoil or structure is unlikely to involve software R&D. However,
the underlying research, design and development programme in these
areas involving theoretical simulation, experimentation and the
correlation of one with the other could.
28. Software
development intended for the analysis of, for example, market
research data, which was not expected to result in the development
of a scientific advance to the software, such as a new algorithm,
would not be considered R&D.
Qualifying
Indirect Activities
29. Supporting
activities that will qualify if part of a larger R&D project are:-
- scientific
and technical information services, insofar as they are conducted
for the purpose of R&D support (such as the preparation of the
original report of R&D findings);
- indirect
supporting activities such as maintenance, security, administration
and clerical activities, and finance and personnel activities,
insofar as undertaken for R&D;
- certain
ancillary activities essential to the undertaking of qualifying
R&D (e.g. taking on and paying staff, leasing laboratories and
maintaining research and development equipment including computers
used for R&D purposes);
- training
required to directly support an R&D project;
- research
by students and researchers carried out at universities;
- research
(including related data collection) to devise new scientific
or technological testing methods, survey methods or sampling
methodologies;
- feasibility
studies to inform the strategic direction of a specific R&D
activity.
Exclusions
from R&D
30. R&D must
be distinguished from a wide range of related activities. In addition
to the activities listed in paragraph 8 above, the following are
examples of activities that would be excluded from R&D, except
insofar as they have been specifically included as potentially
qualifying indirect activities at paragraph 29:-
- general
education and training;
- scientific
and technical information services;
- general
purpose data collection;
- calibration
of standards and routing testing and analysis of materials,
components, products and processes;
- the acquisition
of rights in, or arising from, R&D;
- routine
computer maintenance or software development;
- specialised
(routine) medical care;
- policy
studies.
Other General
Exclusions
31. A major
source of difficulty in classifying work as R&D occurs at the
interface between genuine R&D and activities related to the innovation
process. General commercial activities will not normally be R&D.
These include :-
- the range
of commercial and financial steps necessary for innovation and
the successful development and marketing of a new product, process
or service;
- the production
and distribution of goods and services;
- administration
and other supporting services not directly related to the R&D
activity;
- general
support services (such as transportation, storage, cleaning,
repair, maintenance and security) not directly related to the
R&D activity.
Department
of Trade and Industry
Notes (not
forming part of the Guidelines)
Application
of the Definition of R&D
The definition
of R&D in S.837A ICTA 1988 applies to chargeable periods ending
on or after 1/4/2000 (corporation tax) and years of assessment
2000/01 onwards (income tax). The definition, extended to include
oil and gas exploration and appraisal, applies for the purpose
of R&D capital allowances (scientific research allowances) in
Part VII Capital Allowances Act 1990 . It also applies to provisions
in Section 82A ICTA 1988. These permit a revenue deduction for
expenditure on R&D related to the trade of the person incurring
it that would not otherwise be allowed for tax purposes. These
provisions were formerly contained in S.136(a) CAA 1990. The definition
of research and development, but without the extension for oil
and gas exploration and appraisal, also applies to the following
provisions:
- enterprise
investment scheme, in relation to shares issued on or after
6 April 2000
- venture
capital trusts, in relation to shares or securities issued on
or after 6 April 2000
- corporate
venturing scheme · enterprise management investment
- R&D tax
credits.
Oil & Gas
Oil and gas
exploration and appraisal do not qualify as R&D under either SSAP
13 or Frascati, and it is specifically excluded from the general
definition of R&D in the new Section 837A ICTA 1988. But oil and
gas exploration and appraisal, as defined in new Section 837B
ICTA 1988, is included within the definition of R&D for the purposes
of research and development capital allowances by special provision
in Section 139(1)(a) CAA 1990. The eligibility criteria are discussed
in more detail in Chapter 3 of the Inland Revenue Oil Taxation
Ring Fence CT Manual.
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