The fundamentals of many areas of tax are relatively easy to understand — but the devil’s in the detail when it comes to R&D tax relief.
Beneath the surface there’s plenty of fine print which can trip you up. Even the most well-intentioned accountants and company directors can make errors that stop claims in their tracks.
Below are some of the most common stumbling blocks to look out for when making an R&D tax relief claim.
It’s important to remember that not every aspect of the R&D process qualifies for relief.
R&D tax relief claims can only be made for qualifying costs that are revenue expenses — in other words, costs that are used to generate revenue in the short term and expensed in the same accounting period as the transaction.
What do we mean by this?
Claims cannot be made for expenses that are capitalised, i.e. added to the cost of a fixed asset and paid for over a period of time via depreciation.
This rule was relaxed in 2005 to allow costs capitalised as Intangible Assets to also qualify, but those allocated to Tangible Assets are not permitted for R&D tax relief.
Sometimes services offered by subcontractors are paid for ‘in kind’, and they are given a reduction in a future sales price, a royalty or even shares in the company.
This can make commercial sense at the time, but anyone considering it should weigh up the longer-term implications, as it will prevent the subcontractor’s time from being included in an R&D tax relief claim.
Anyone embarking on an R&D project now or in the near future should also bear in mind that, from April 2023, overseas subcontractor and externally provided worker costs will also be excluded from claims.
Some firms rely heavily on grants in order to get the up-front funding they need to embark on a project.
However, any business that depends upon subcontractors for their R&D should think about the pros and cons of using this funding method prior to applying for the grant.
This is because, although grants do not preclude R&D tax relief claims, they can push the claim into the less generous Research and Development Expenditure Credit (RDEC) scheme used by larger businesses.
Under the RDEC scheme, costs cannot be claimed if the subcontractor is a company — which they often are.
Sometimes it is commercially beneficial for some staff to avoid drawing a salary during the early stages of R&D. However, doing so will reduce the amount that can be claimed under R&D because any compensation received will not qualify for relief.
Dividends do not qualify either, so it may be better to receive a salary instead. In April 2021, HMRC introduced the PAYE cap for loss-making companies, making these issues more prevalent. The PAYE cap links payable credits to the amount a company pays in tax and NIC deductions.
Meanwhile, a quirk in the rules means that some reimbursed expenses that relate to R&D, such as travel costs, can be claimed. However, this excludes those that are paid directly by the employing company.
There is no one-size-fits-all to R&D record keeping, but the more a business can do, the more accurate the claim will be and the faster it can be processed.
HMRC does not expect companies to keep separate R&D costings, but there are ways of ensuring no qualifying costs are missed.
At the very least, we want to see payroll records and example invoices for materials, subcontractors and software, plus copies of expense claims for reimbursed expenditure. The more accurate the records are, the more robust the financial aspects of a claim, and the easier it is to deal with any HMRC enquiry.
Larger entities, or those with previous R&D tax relief claims, may be expected to keep better R&D records. This does not necessarily require a new book-keeping system, but can involve keeping timesheets for R&D projects, or posting materials invoices to a job costing system that relates to a particular project.
There is always an element of administration and maintenance that attaches itself to R&D work too. This is called Qualifying Indirect Activity and, even if a timesheet system is adopted, these costs will usually need to be extracted separately for the claim.
Keeping track of capital expenditure is also beneficial in assisting with a Research & Development Allowances (RDA) claim.