It’s more important than ever that innovating companies ensure all costs eligible for tax relief are correctly identified, apportioned, and claimed under the correct research and development (R&D) scheme, so they receive everything to which they are entitled.
Changes to what is eligible for R&D tax relief are still proving to be stumbling blocks for businesses and accountants navigating this complicated terrain.
Given that R&D tax relief is currently under significant scrutiny from HMRC, it is vital that all elements claimed are compliant under the legislation.
To shed some light on what can be claimed, as well as recent changes, here are the most common costs that can be included in R&D tax relief claims.
Staff costs include costs associated with directors and employees of the innovating company who actively engaged in the R&D. They also include costs for staff engaged in qualifying indirect activities, which are part of the project but don’t contribute to the resolution of a technological or scientific uncertainty.
Qualifying staff costs include salaries, bonuses, Class 1 National Insurance contributions, employer pension contributions, and reimbursed travel costs related to R&D (though not those paid through a company card or paid by the company directly). Dividends and benefits in kind do not qualify, however.
Critically, the amount of qualifying staff costs is based on the proportion of time spent by each of the R&D staff on the projects during the claimable period. HMRC considers that all staff normally carry out some non-R&D activities, so care should be taken when determining the time apportionments, as 100% may not be seen as feasible.
Externally Provided Workers (EPW) and Subcontractor Costs
Qualifying subcontractor costs vary depending on whether they are claimed under the small and medium-sized enterprise (SME) scheme or R&D expenditure credit (RDEC) scheme, which is for claims from larger companies and smaller businesses not able to claim under the SME scheme.
Under the RDEC scheme, costs can only be claimed when the R&D activity is carried out by a prescribed body, which includes individuals, partnerships, charities, higher education institutions, scientific research organisations, or health service bodies. This means if a subcontractor is a limited company, its cost will not be claimable under the RDEC scheme.
Under the SME scheme, 65% of EPW and subcontractor costs can be claimed if the worker and the subcontractor company are not connected to the claimant company. If they are connected, there is no 65% restriction, and claimable costs will be based on the lower of the payment made to the subcontractor/staff provider and the relevant expenditures.
One major change to R&D legislation means that from April 2024, expenditure on R&D activities that take place abroad will no longer qualify. Therefore, if EPWs are engaged to carry out R&D work, their earnings must be subject to the UK PAYE regulations. Exemptions may apply if the conditions necessary for the R&D are absent in the UK and it would be wholly unreasonable for the claimant company to replicate them in the UK.
Consumable and Prototype Costs
Claimable material costs are those that have been wasted, consumed, or transformed during the R&D activity to the extent they cannot be reused in their original form or sold. This includes the proportion of utilities (water, fuel, and power) consumed in the R&D process.
If the prototype itself is sold, then only the costs associated with the design, modelling, and testing are claimable, whilst the construction costs and materials consumed are not.
Where consumable items are only partly employed in R&D, an appropriate apportionment of the expenditure should be made.
Software, Data Licence, and Cloud Computing Costs
The costs of computer software that is directly employed in the R&D activities, including “qualifying indirect activities,” can be claimed.
The government has recognised that computing technology has moved on substantially and has introduced new eligibility rules around data and cloud computing. Its introduction modernises the R&D scheme, ensuring legislation keeps pace with new technologies and trends.
Since 1 April 2023, costs incurred for the following activities that relate to R&D activities have become eligible:
- Buying a data licence to use data sets. (This doesn’t include the costs associated with purchasing of data that can be resold, or deemed as assets of the company, which will be treated as a capital expenditure that is unclaimable.)
- Paying for cloud computing services such as cloud data storage.
Where software, data, or cloud services are only partly employed in direct R&D, an appropriate apportionment of the expenditure should be made.
What You Need to Know
All the above claimable costs must be accrued as expenditure within the company’s Profit & Loss account and within the claimable accounting period or capitalised as intangible fixed assets during the period. In addition, the staff costs must be paid no later than nine months from the end of the accounting period, and other R&D costs have to be paid by the time the R&D claim is made.
While innovative companies should take full advantage of the available tax relief, it is critical that only the eligible activities are claimed. This can be complex where apportionment exercises are required, such as in staff, materials, or software costs. It is beneficial to work with a reputable R&D tax specialist to help maximise the claim and ensure it stays compliant with the legislation, making it less open to an enquiry from HMRC.
Emily Lue is a senior consultant at leading global tax services and software provider Ryan. She can be contacted at email@example.com