By Nigel Holmes, Senior Tax Specialist at Catax
Accounting for Research & Development Costs
Firstly, why is this important when we are not accountants? Well, the tax relief available for both the SME scheme and Research and Development Expenditure Credit (RDEC) relies on there being qualifying costs. A qualifying cost must be revenue in nature (see below) and be deductible for corporation tax (hence why dividends do not qualify for R&D tax relief); and the starting point for a company’s corporation tax computation is its profit or loss before tax taken from the accounts. Hence, this is why the accounting treatment may cause problems with an R&D tax relief claim if costs are accounted for incorrectly.
The “Statement of Comprehensive Income” or “Income Statement” or, as most people still know it, the “Profit and Loss (P&L) account”, is where costs of a revenue nature are usually found. These costs include the likes of wages and salaries, purchases, lighting and heating and subcontractor costs; so it is where R&D qualifying expenditure is usually found.
The “Statement of Financial Position” or “Balance Sheet” as most people know it, is for the costs relating to assets and liabilities. These are known as “Capital Costs”. This is where costs that may qualify for Research & Development allowances (see June edition of Tax Talk) are to be found in tangible fixed assets.
Some accountants post transactions in the most weird and wonderful places. For example, machinery costs that should be capitalised onto the balance sheet are included in the P&L account. This will not assist in an R&D tax relief claim as the costs are still capital in nature and do not fall into any of the qualifying costs categories (machines are usually not consumed in R&D). Likewise, revenue costs that would qualify for R&D tax relief are sometimes capitalised. Whilst they will still maintain their revenue status they lose the ability to be included in an R&D tax relief claim because they have not qualified for tax relief as the tax computation follows the accounts, as stated above. I have seen R&D tax relief claims fall away as costs are put into tangible fixed assets or even debtors!
There is an exception though.
International accounting standards allow R&D costs to be capitalised as intangible fixed assets. HMRC altered the R&D tax relief rules such that any such accounting treatment with effect from 1 January 2005 do still qualify for R&D tax relief. There are some points to note here:
I recently came across a case where the accountant had capitalised some R&D costs as intangible assets, and some costs were in the P&L account. The accountant made an R&D claim on some costs, without discussing it with the client! The accountant then, when we took over, told the client that losses could not be surrendered for cash if costs have been capitalised (this is wrong, the rules are no different). The accountant also claimed Research & Development Allowances (RDAs) on the balance of the R&D costs capitalised as intangible assets, even though they were revenue costs such as wages. Luckily, Catax were appointed and we have unravelled the mess created.
We will find times in phase 1 cases where the accounting treatment reduces or prevents a claim. Unless the client wants to re-file accounts at Companies House and HMRC, a step that is both onerous and may raise eyebrows as to the company’s inadequate accounting records, not forgetting the additional cost, we may need to accept the fact that the claim is not what it could have been; but I can help point people in the right direction for live accounting periods.
If anyone has any queries about the accounting treatment of costs please let me know.