Identifying the correct type and amount of R&D expenditure is important to maximise the size of your R&D tax relief claim. R&D tax relief is only available for expenditure which meets certain conditions and that falls within certain types of qualifying expenditure.
In this article, we discuss what can be included as direct qualifying expenditure and some of the indirect costs that are often overlooked by tax advisers and accountants.
Payroll of staff involved in R&D
Costs include salaries, wages, National Insurance, bonuses, and employer’s pension contributions of staff directly involved in R&D activity. The cost of administrative or clerical staff can be included for time spent directly facilitating R&D projects. For example, writing up project meeting notes, recruiting specialised personnel, or sourcing specific materials etc.
The amount, or a proportion of the amount paid to R&D staff hired on a temporary basis through external agencies can be considered qualifying R&D expenditure. However, you can only claim up to 65% of the payments made to the external agency and VAT paid as part of this would not qualify as an R&D cost.
Subcontractors for R&D
Your company can claim up to 65% of the payments made to subcontractors for R&D projects, whether they be based in the UK or overseas. For example, if your UK based company has engaged software developers from Poland to develop a unique software product, you can claim up to 65% of the payment made to the developers as R&D expenditure.
However, the government plans to limit the support for innovation occurring outside of the UK in its Finance Bill 2022-23. The government intends to disqualify expenditure where R&D activity is subcontracted to an overseas third party. However, R&D tax reliefs may still be claimed for the cost of software, data, cloud, and consumables sourced from overseas. The reforms will take effect from April 2023. Read more.
Qualifying Indirect Activities (QIAs)
Within the HMRC guidance and BIS R&D guidelines (paragraph 31), a list of claimable activities is provided that can have a significant impact on the level of financial rewards received from the claimant.
Many activities that form part of an R&D project do not directly contribute to resolving a scientific or technological uncertainty. However, according to the BEIS guidelines, they can still be included in a claim.
The guidelines say:
“Activities which form part of a project but do not directly contribute to the resolution of the scientific or technological uncertainty include:
- 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.
- Ancillary activities essential to the undertaking of 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, survey, or sampling methods, where this research is not R&D in its own right.
- Feasibility studies to inform the strategic direction of a specific R&D activity.”
Businesses may claim costs for materials, water, fuel and power that have been consumed by the R&D process.
Sometimes overlooked is the fact that you can include an amount for your light, heat and water costs in your R&D tax credit claim. The total cost recognised in your profit and loss account can be apportioned between R&D and non-R&D activities on a just and reasonable basis. This may only have a modest impact on your claim but can be significant for energy intensive R&D activities.
Software used directly in R&D
You may be able to claim the full costs (or a proportion) of the software directly used for R&D activities. For example, the amount spent on Amazon Web Services (AWS) for the development of a SaaS product in an R&D project.
Data and cloud costs
The government has recognised that datasets and cloud computing are important R&D inputs for companies in many sectors. To that end, new categories of R&D expenditure have been brought into scope, along with caveats:
- Licence payments for datasets – so long as the data cannot be resold or has lasting value beyond the duration of the R&D project.
- Cloud computing costs associated with computation, data processing, analytics, and software – general overheads relating to cloud server rental costs or data storage remain out of scope.
The government has stressed that staffing costs for creating datasets for use as part of R&D projects remain inside the scope. This includes staff costs for collecting, cleansing, and analysing data provided they are incurred for a qualifying R&D project.
The design, construction, and testing costs of a prototype to test the R&D undertaken may be claimed under the SME scheme. However, the costs associated with a prototype that is built for sale cannot be claimed under the scheme.
What costs don’t qualify as R&D expenditure?
Costs which you usually will not be able to claim under the scheme are those associated with the production and distribution of goods and services (such as sales and marketing), capital expenditure and payments for the use and creation of patents and trademarks.
Dividends paid out to directors also do not qualify as R&D expenditure, even if the Directors have participated in R&D activities on behalf of the company. However, if the Directors have contributed to R&D projects and are paid salaries, a proportion of their salaries would still qualify as R&D expenditure.