Yes. Designing, building and testing a prototype to resolve a scientific or technological uncertainty is R&D, and selling it afterwards does not take that work back out of the claim. One category of cost does drop out: the consumable materials that ended up inside the item you sold. And where the item was always going to be sold — a first article built against a customer order — the boundary tightens across every cost category, because part of that build meets the customer’s order rather than resolving the uncertainty.
Which costs survive the sale, and which do not?
Where the unit was built for the R&D and sold afterwards, the restriction is a consumables rule and nothing wider. Expenditure on consumable items does not qualify where the R&D relates to an item produced in the course of it, the consumables form part of that item, and the item is transferred for money or money’s worth in the ordinary course of the transferor’s business. The same applies where the R&D is into a production process and the consumables end up in what that process makes. Staff costs, externally provided workers, subcontracted R&D and software sit outside the restriction entirely: an engineer’s time on the prototype is claimable whether or not it is later sold. Which costs qualify for R&D tax relief sets out the six categories and what each one excludes.
Three details settle most cases.
- A sale is not the only trigger. Transfer covers possession as well as ownership, so letting the item out on hire counts, and it can be made by any “relevant person”: the company, the contractor it engaged, the customer that contracted the work out, or anyone connected with them. A unit sold on by a sister company is caught. Incorporating the item into something larger does not break the chain either: transferring the larger thing transfers the item inside it.
- Waste is not a sale in the ordinary course of business. The legislation says so. HMRC treats four further situations the same way: an inevitable by-product of the R&D, an unintended consequence of it, a fortuitous sale of something the company does not usually sell, and a sale at a price below the cost of the consumables inside the item. Falling outside the ordinary course is not enough on its own: the consumable must still have been employed directly in the R&D.
- Part sold, part kept. Where only some of the output is transferred, only that proportion of the consumable cost comes out. Material scrapped, held back for further testing or sold as scrap stays in.
Handing a unit out for evaluation is different. Information obtained from testing an item is not consideration for transferring it, so lending or giving a prototype to a potential customer for trial data does not trip the rule.
What if the item was always going to be sold?
Then it is not a prototype in the sense the Guidelines use, and less of the build qualifies. The Guidelines treat work to create materials or equipment as directly contributing only where the thing is created solely for use in the R&D: a prototype, in that sense, is a single-purpose unit built for the project and not for sale. HMRC calls the alternative a first-of-class item: a build whose cost, in money or in time, makes it uncommercial to construct a separate unit purely for the R&D, so the company builds the article it will deliver and resolves the uncertainty along the way.
HMRC’s position is that in most cases the total build cost of a first-of-class item is not expected to qualify, because the build meets a customer order as well as resolving uncertainty. What qualifies is the work directly contributing to that resolution — in HMRC’s example, the design, build and testing of the sub-assembly where the uncertainty sat. The rest falls within the production and distribution of goods and services, which the Guidelines put outside R&D. Consumables used in the qualifying work qualify too, apart from those that end up in the article finally handed to the customer — in that example, the materials in the sub-assembly as finally fitted. The split has to be demonstrated by the company rather than assumed. What makes that demonstrable is the baseline: the parts of the build the company could already deliver with existing technology, set against the parts where it could not. Services follow the same logic: a practice designing to a customer’s specification claims the advance-seeking work, not the whole job. This is the line manufacturing, engineering and agritech claims have to draw — for agritech, on pilot plots and the produce a field trial yields.
When does R&D end and production begin?
R&D ends when the uncertainty is resolved or the work to resolve it stops. The Guidelines give a second, harder marker: the knowledge codified in a form a competent professional could use, or a prototype or pilot plant with all the functional characteristics of the final product. Once the resulting modifications have been made and retesting is satisfactorily complete, later work is not R&D. Building and running a pilot plant follows the same rule: R&D while the uncertainty remains, and not after. What counts as qualifying R&D sets out the advance and uncertainty tests in full.
Production trials sit in between and are apportioned. Where a trial run is needed to establish whether the advance has been achieved, its costs qualify up to the point the uncertainty is overcome and not beyond. A run performed only to validate a process that carries no remaining uncertainty does not qualify at all. The same reasoning applies to certification: obtaining regulatory approval for a product whose functionality is already proven is not R&D, though work to achieve a further advance the approval demands can be. What doesn’t count as R&D takes the exclusions further.
What should a claim record?
Track what happened to each item and when. HMRC’s worked examples turn on whether a transfer has taken place in the period: a unit kept back for further development keeps its consumable costs in that period’s claim, and they fall out in the period the sale happens. Record which units were sold, scrapped, loaned out for evaluation or still on site, and keep the bill of materials for each. For a first article, record the sub-assemblies the uncertainty sat in and what share of the build they represent. The records behind a claim sets out what that file needs to contain.
If a prototype or first-article build sits in your claim, talk it through with a chartered adviser.
Sources
- Guidelines on the meaning of R&D for tax purposes — paragraph 27(a), activities to create materials or equipment directly contribute “provided that the software, material or equipment is created or adapted solely for use in R&D”; 28(c), the production and distribution of goods and services does not directly contribute; 33 and 34, when R&D begins and ends, including the prototype or pilot plant “with all the functional characteristics of the final process, material, device, product or service”; 39, the design, construction and testing of prototypes generally fall within R&D, and further work does not once retesting is satisfactorily completed; 40, pilot plants.
- CTA 2009 s1126A — subsections (1) and (2), consumable items forming part of an item produced in the course of the R&D, or by a process the R&D relates to, and transferred by a relevant person for consideration in money or money’s worth in the ordinary course of that person’s business; (3) and (4), apportionment where only a proportion is transferred; (6), what “forms part of” means; (7), transfer of ownership or possession, and the transfer of a larger item into which the item is incorporated; (8), information obtained in testing is not consideration; (9), waste; (10), the definition of “relevant person”, which extends to contractors and connected persons.
- CTA 2009 s1126 — subsection (7): the general attributable-expenditure rule is subject to sections 1126A and 1126B. Section 1126B is a Treasury regulation-making power over the same ground.
- Finance Act 2015 s28 — subsection (7): the amendments inserting sections 1126A and 1126B have effect in relation to expenditure incurred on or after 1 April 2015.
- CIRD81350: production and distribution of goods and services — HMRC on prototypes as single-purpose units not built for sale, including loan or gift for evaluation in exchange for information; first-of-class items intended for sale from the outset, where total build costs are not expected to qualify and the company must demonstrate which activities directly contributed; manufacturing trials apportioned to the point the uncertainty is overcome; consumables in output sold as scrap or a recyclable by-product remaining qualifying; and services considered in exactly the same way as goods.
- CIRD82300: consumable items — the Finance Act 2015 restriction, worked examples of a sold kiln and a soft-drink production process, projects spanning more than one period, and the four transactions HMRC treats as outside the ordinary course of business.
- CIRD82400: meaning of consumed or transformed — components integrated into a larger assembly are transformed into part of a prototype, and the Finance Act 2015 rules may then apply if the prototype is sold.
- Help to see if your work qualifies as R&D for tax purposes (GfC3), part 4 — testing after the uncertainties have been resolved does not qualify, and regulatory certification of a product with already proven functionality is not R&D unless it requires further advances.
This page describes the rules as they stood at the review date above, as general information rather than advice on your circumstances. For how that distinction works, see our terms; for an answer on your own facts, talk to us.