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Which of my costs qualify for R&D tax credits?

There are a variety of rules around which parts of your overall R&D expenditure qualify for inclusion on your R&D claim. There are also some differences between the SME Tax Credit Scheme and the RDEC scheme.

Here are a list of the main qualifying costs with their most defining features and a handy shortlist of costs that you can’t include:

  • Consumables
    This refers to any actual materials you use during your R&D activities, like making product prototypes. It also includes broader costs like water, fuel and power, proportionate to their use for specific R&D projects.

  • Software
    The cost of software that you use as part of your R&D projects does qualify for R&D tax credit. It you partially use it for other work, as well as on particular R&D projects, then you only claim for the equivalent proportion that is spent on R&D.

  • Clinical Trials
    This is very specific to the pharmaceutical industry, who use clinical trials to test new drugs on people. The cost of paying these volunteer guinea pigs can be included in your R&D claim.

  • Staffing
    Both SMEs and large companies can claim some staffing costs.

    • Employer NI contributions
    • Salaries: the gross amount and with bonuses and overtime
    • Reimbursed business expenses: if they are costs incurred solely when working on an R&D project
    • Employer pension contributions: the pension fund or scheme does not have to be based in Britain to be eligible

Clarification around reimbursed expenses

There has been some confusion around this aspect of the rules. Firstly, reimbursed expenses means a cost that your employee has paid for that you later give them back. Things like company credit card payments don’t count because the employee is not involved in the interaction.

For eligibility under R&D tax credit schemes, the cost must pay for something that is intrinsically part of the R&D project. Travel and subsistence costs are back on the agenda; benefits-in-kind, daily commute and training are not.

Confusion has arisen because HMRC have made changes to their guidance on reimbursement as qualifying expenditure under R&D tax credit schemes. The first 2009 guidance clearly allowed for employee expenses to be included. An amendment to the rules in 2014 changed the definition of staffing costs, which then referred solely to contractual costs. This excluded employee travel and subsistence expenditure.

In October 2016 this was changed back to the original inclusive definition in a change to HMRC’s online manual for the administration of R&D Tax Relief. Unfortunately, the absence of a retraction left some confusion. This was then resolved in July 2017, when HMRC announced way for companies to claim for the staff costs they excluded from R&D tax relief claims during the 2014-16 period.

Now the main areas of employee travel and subsistence are clearly included as allowable costs for an R&D tax credit claim. This does not include training, benefits-in-kind or commuting costs to and from their workplace. This is background that may not be absolutely necessary.

What about subcontractors?

There are two different sets of rules for subcontractors for the separate RDEC and SME schemes:

  • SMEs and subcontractor costs
    SMEs are entitled to claim for 65% of their subcontractor costs that are spent working on R&D projects.
  • RDEC and subcontractor costs
    There are more stringent rules around the type of subcontractor for those applying under the RDEC scheme. The subcontractor must be a health organisation, academic institution, charity or scientific research body an individual or a partnership of individuals in order for you to be able to claim their R&D work as an allowable expense. The good news is that you can claim for 100% of your subcontractor costs.

For both schemes, the work being done by the subcontractor need only be defined as part of the overall projects, not necessarily R&D in and of itself. Also, your subcontractor isn’t required to be a British resident, nor does the work itself have to be done in the British Isles.

There are further factors which are taken into consideration by HMRC when they are looking at the subcontractor-contractor relationship. These include:

  • You own the intellectual property of your R&D innovation.
  • You are taking the risk of the project’s failure. Ie: your subcontractor is paid regardless of the project’s outcome.
  • Your subcontractor works to the specifics that you have provided.
  • How much you control how the subcontractor deals with the uncertainties of the project.

Externally Provided Workers

This is the umbrella term for your employees that you have sourced from an agency. Their contract of employment and their pay all go through an agency, rather than directly through your company. You can claim for the time they spend working on your R&D projects whilst under your direction.

Providing evidence of staff costs

It’s a great idea to have your record system set up at the start of your R&D project. Then you can log the amount of time your staff spend working on R&D directly and when it comes to making a claim, it’s all there ready. HMRC do not prescribe a format for this to be done on as what works smoothly for you might be a time-consuming nightmare for another company.

Which costs do not qualify for R&D tax credits?

Costs not allowable for an R&D Tax Credit claim:

  • Production costs of a new product

  • Legal costs

  • Marketing and advertising

  • Sourcing funding

  • Market research

This is not an exhaustive list, but a good place to start ruling things out.

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