Guide to R&D tax incentives part two: What activities and costs qualify for R&D tax relief?
For a project to qualify as R&D it must meet HMRC’s criteria which states that, “a project must constitute an advance in science or technology that’s defined as an improvement in overall knowledge and capability through resolving scientific or technological uncertainty.”
How does that definition help a business confidently assert if a project qualifies? Consider the 3 Cs:
- Certainty – At the start of, or during, a project was there any uncertainty that the undertakings would be successful?
- Competent professional – Do you have competent, qualified people working on the project?
- Common knowledge – Does the project achieve something that few others have achieved or is not widely known?
If the answer to some or all these questions is ‘yes’ then it is highly likely that qualifying R&D is taking place.
Types of qualifying projects
R&D doesn’t just apply to developing a new wonder drug or producing the first driverless car, it can apply to any new development or gradual enhancement of a product in the fields of design, IT, technology, engineering or science. This not only applies to saleable products, but also to systems and technology that are used as part of a business to improve efficiency, reduce costs or automate processes.
Most successful companies are continually striving to find an edge over their competition and the tax system is designed to reward this type of behaviour. The challenge is identifying all relevant costs and defining the scope and extent of a project.
A project doesn’t necessarily need to be successful to qualify as R&D! Many companies regularly fail to meet project objectives, but if the process undertaken demonstrates uncertainty, it may qualify for R&D tax credits.
Costs – what does and doesn’t qualify
Many different costs qualify for R&D tax relief, but the challenge is correctly accounting for these. The main types of qualifying expenditure are:
- External contractors and subcontractors
- Consumable materials
Once identified, an analysis will then need to be carried out to correctly apportion these costs to a relevant R&D project. For instance, a staff member may only work a percentage of her time on a qualifying project, while the rest of her time is spent engaged in normal day-to-day tasks. Therefore, only the appropriate proportion of that staff member’s salary can be used for the purposes of R&D. The same applies to utility costs, where only a small area of a manufacturing plant may be the designated R&D – only that proportion qualifies for tax relief.
Detailed records and supporting information should be kept, ensuring a robust support of a claim can be made in the event HMRC query an R&D tax credit claim. HMRC provide detailed guidance as to what costs qualify but this hasn’t stopped companies and their advisors including expenditure that is outside the spirit of the legislation. This approach will almost certainly attract the attention of HMRC, resulting in a discovery assessment, or worse, a rejection of the entire claim. This will be addressed more fully in next week’s instalment of this series.
There are detailed rules for subcontracting and the below table provides a simple rule of thumb.
Entitlement to claim*
|Main contractor type||Subcontractor type||Scheme claim is made under|
|SME*||Large company||SME scheme|
|Large company||Large company*||
|Entitlement to claim*|
Of course, if there is any doubt we recommend that you ask a specialist to review both parties involved and the contract under which the work is carried out.