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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.
This
note discusses the meaning of research and development (R&D) for
tax purposes. The new definition of R&D was introduced in the
Finance Act 2000.
28 July 2000
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. S.837B
ICTA 1988 defines "oil and gas exploration and appraisal". The
definition of R&D is expressly extended to include oil and gas
exploration and appraisal in certain situations, in particular
for research and development allowances (the new name for scientific
research allowances) in Part VII CAA 1990.
Definition
of R&D
3. The overarching
definition of R&D for tax purposes follows that used for the purposes
of normal accounting 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 SSAP 13
does not include the R&D in the humanities. 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 is founded on the definition of R&D in
SSAP 13, but greater certainty is given through regulations that
can prescribe activities that are, or are not R&D for tax purposes.
The regulations may do this by reference to Guidelines issued
by the Secretary of State for Trade and Industry..
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 successful). 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 will 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 is
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 form 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;
- adaption
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
will 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 will qualify.
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(1)
:-
- 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 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.
Secretary
of State for Trade and Industry
28 July 2000
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 the provisions that adopt
this definition for chargeable periods ending on or after 1/4/2000
(corporation tax) and years of assessment 2000/01 onwards (income
tax).
"R&D" is
expressly extended to include oil and gas exploration and appraisal
(as defined in Section 837B) the purpose of R&D allowances (the
new name for 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 expressly brought within the definition of R&D for
the purposes of research and development 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.
Footnotes
1. These
guidelines do not apply for the purpose of defining scientific
research expenditure for determining the objects of a body to
qualify for the Secretary of State's approval as a scientific
research association; in this context, reference should be made
to the Department of Trade and industry's section 508 Guidance
Notes for Applicants
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