What Costs Can Be Claimed Through R&D Tax Credits
Research and Development (R&D) is a crucial aspect of innovation and growth for businesses in the United Kingdom.
It allows businesses to develop new products, processes, and technologies that can drive their competitiveness and success. However, R&D can also be a costly process, which is why the UK government provides R&D tax credits as an incentive for businesses to invest in this area. R&D tax credits can help businesses reduce their tax bills and reinvest their savings back into their R&D efforts.
In this blog, we will explore what costs can be claimed through an R&D tax credits claim for a UK business, so that you can maximise your savings and reinvest in your innovation and growth
What are R&D Tax Credits?
R&D tax credits are a form of tax relief that the UK government provides to incentivise businesses to invest in research and development. The relief is designed to encourage innovation and increase competitiveness among UK businesses by reducing their tax bills. The R&D tax credit scheme is available to businesses of all sizes, across all sectors, and can help to offset the costs of R&D activities such as developing new products or processes, improving existing ones, or advancing technology.
There are two types of R&D tax credits available to businesses in the UK: the SME R&D tax credit and the Research and Development Expenditure Credit (RDEC). The SME R&D tax credit is available to small and medium-sized enterprises (SMEs) and provides up to 33.35% tax relief on qualifying R&D expenditure.
The RDEC is available to large companies and provides up to 13% tax relief on qualifying R&D expenditure. Both schemes offer cash back or reduction in tax liability, depending on the size of the company and their taxable profit status.
To qualify for R&D tax credits, a business must demonstrate that they are undertaking qualifying R&D activities. These activities must seek to achieve an advance in science or technology and involve the resolution of scientific or technological uncertainties.
So what costs can R&D Tax Credits cover?
R&D tax credits in the UK can cover a wide range of costs associated with qualifying research and development activities. These costs can be claimed by businesses to reduce their tax bill or receive cash payments. Here are some of the costs that are typically covered by R&D tax credits:
1) Staff Costs:
Paying people is one of the biggest outgoings that most companies face, and it’s likely that these costs will increase if you are involved in R&D.
If you are undertaking a new project that is proving to be challenging, you may decide you need to employ more staff. Luckily you will be able to claim back some of these costs using R&D Tax Credits. It covers things like salaries, employers NICs, company pension contributions and even reimbursed expenses. You can also claim back agency workers that are involved in the R&D process, however this will be restricted to 65% of the agencies invoice value.
It is not uncommon for an R&D team to consist of many individuals from different parts of the business. Your R&D project team may include the R&D Manager, a Lead Developer, Engineers, Project Co-ordinators, CAD Engineers, Quality Control and Testing specialists, and Cost Accountants, as well as members of the senior management team. Again, the costs of employing these people to carry out the R&D project can be included in an R&D Tax Credits claim.
When it comes to R&D Tax Credit claims, staff costs are classed as eligible expenditure. But only the costs of employees and directors who are engaged directly in applicable R&D activities can be classed as eligible. If only a proportion of an employee’s or director’s work is taken up in relevant R&D, the relative proportion of their time (and costs) can be included in your claim.
Learn more on how to allocate staff time for an R&D tax credit claim.
2) Sub-contractors and freelancers:
After the 2021 Spring Budget, the UK government announced its intention to evaluate the R&D Tax Credits scheme concerning the treatment of subcontractors and Externally Provided Workers. This significant changes will have an impact on numerous businesses throughout the country.
How does it work currently? (as of 15th Feb 2023)
When a company hires another entity, such as a person or business, to perform R&D work on its behalf, it is considered subcontracted R&D.
Small and medium-sized enterprises (SMEs) can typically claim 65% of the eligible costs of subcontracted R&D, as long as the subcontractor is not connected to the company. If the subcontractor is connected, such as a subsidiary or branch, then the claim will be based on either the eligible expenditure of the contractor or the R&D payment made to them, whichever is lower.
Companies claiming under the RDEC branch of the scheme can only use subcontractors that are individuals, partnerships of individuals, or qualifying bodies. Currently, subcontractors do not have to be based in the UK, and the R&D work does not have to take place in the UK. Additionally, the work carried out by the subcontractor does not have to be R&D in isolation, but it should be an essential part of the company's broader R&D project.
Starting April 1st, 2023, UK businesses will no longer be eligible to claim R&D costs for research and development activities that take place abroad. Currently, a UK-based company can have an R&D team operating in a different country, and the UK government would foot a significant portion of the bill.
However, this will come to an end under the new rules. Although this change may save the government money in theory, it could have a severe impact on UK companies that subcontract their R&D overseas. It may also reduce the appeal of international collaborations between the UK and other countries.
There will be limited exceptions for instances where specific conditions, such as geography, environment, population, or regulatory requirements, necessitate research in particular territories, such as deep ocean research or clinical trials. However, these exceptions will not apply to cost or workforce availability.
3) Materials and consumables:
Consumable items are items that are directly employed, consumed or transformed in the R&D process. They must be consumed in any activity that is considered R&D for tax purposes, which includes ‘qualifying indirect activities’. This definition applies to both the SME scheme and the RDEC scheme, for small and large companies.
Most often, ‘consumable items’ refers to utilities (fuel, water, power) and materials directly used in the R&D process. Chemicals and other substances used in the process can be counted, even if they are later recycled to be used again.
These costs tend to be the smaller proportion of a claim, however keeping good records of them can quickly build into a substantial portion of the costs being claimed. HMRC understands that with many of these examples, like power and water, it can be hard to split bills between R&D and non-R&D costs, so they will accept reasonable estimates based on the requirements of the R&D.
Fixed assets do not fall under the umbrella of consumables, as they have ongoing value to the company. However, capitalising on R&D expenses can open the door to Research and Development Capital Allowances (RDAs).
How will the 2015 Finance Act change affect your claim?
The rules around R&D tax credits and consumable items were updated in 2015 to further clarify the meaning of consumable items and to close a loophole that allowed some companies to be paid twice for their costs.
Previously, companies whose R&D processes were heavy in consumable use could run a R&D trial, sell the items produced and claim the cost of the materials in their R&D tax credit claim, essentially covering the costs of production twice. Seeing as this was not in the spirit of the rules, HMRC updated the legislation to disallow companies to claim for consumable costs for items sold. This means that if you create a product at the end of the R&D process and then sell it, you cannot claim for the costs associated with making the product sold. For example, a company trialling a new kiln which is more heat resistant could not claim for any consumables used in the R&D process (like propane gas, which is combusted in the kiln and transformed physically into the kiln lining), as they have been sold on and thus, paid for.
Prototypes can still be claimed for, but only if they are used for R&D – if they have a demonstrative purpose, like at a trade show, they are exempt from R&D tax credit expenditure. Furthermore, there are changes to ‘first of class’ production, or expensive items for which prototypes cannot be made, like yachts and skyscrapers; where R&D activities used to be claimable within larger builds as consumables, this rule has also been scrapped.
The best you can hope for is to claim for wastage, as consumable items which are not entirely sold/transferred can still be eligible if apportioned. Furthermore, if your project spans more than one accounting period and the item is only sold later, the periods during which the product had not been sold can include the consumable items used in that period.
What should you do now?
The rules for consumables mostly affect sectors like refineries, manufacturing, aeronautical, shipping and pharmaceutical. If your projects occur in these industries, it’s best to get in touch with an R&D specialist who can confirm exactly how your claim could be affected.
Other fields may be affected less, however they should still take a considered look at their record-keeping. The legislation means you have to ensure that everything is above board or risk an enquiry from HMRC, which could affect the time it takes for you to get your entitlement or even the amount of money you receive.
Comprehensive record-keeping which is detailed and up-to-date will make your life far easier when it comes to going through money spent for your eligible expenses. This is the case if you make your claim yourself, or through a trusted R&D tax advisor.
One of the categories of costs that can be claimed is software costs, which are incurred in direct support of R&D activities.
This can include the cost of purchasing, renting, or developing software that is used to carry out R&D. Examples of software that can be claimed include scientific modeling software, simulation software, and software used for data analysis.
To qualify for the credit, the software must be used directly in the R&D process and be integral to the scientific or technological advancement sought by the project. It is worth noting that general-purpose software or tools, such as office software or project management software, are not eligible for the credit unless they have been modified or customized for the R&D project.
Utilities can be claimed as part of the costs of running an R&D facility or laboratory, such as electricity, gas, water, and oil.
However, it is important to note that only the proportion of utilities that relates directly to the R&D activities can be claimed. This means that if only part of a building is used for R&D, only that proportion of the utilities can be claimed. It is also important to keep accurate records of the costs and to be able to demonstrate that they were directly incurred in support of the R&D activities.
6) Clinical trial volunteers:
These trials can be an essential part of the R&D process, especially in the pharmaceutical and biotechnology sectors. Some of the costs of clinical trials that may be eligible for R&D tax credits include the costs of planning and conducting the trial, the cost of medical supplies and equipment, the cost of recruiting patients, and the cost of analysing and reporting the trial results.
It is important to note, however, that not all costs associated with clinical trials are eligible for R&D tax credits. For example, costs associated with marketing, sales, and distribution of the product resulting from the trial are not eligible. Additionally, only costs associated with trials conducted to gain regulatory approval or to improve the performance or effectiveness of a product will be eligible for R&D tax credits.
The clinical trial must also meet the requirements of the R&D tax credit legislation and be conducted in compliance with all relevant regulations and guidelines.
In conclusion, claiming R&D tax credits in the UK can be a valuable way for companies to offset the costs of their research and development activities.
The costs that can be claimed are varied and can include everything from employee wages and software expenses to rent and utilities. It is important to keep detailed records of all R&D costs, as well as to ensure that they meet the requirements set out in the R&D tax credit legislation.
By taking advantage of the R&D tax credit scheme, UK businesses can be incentivised to continue investing in innovative R&D, ultimately helping to drive growth and create new jobs.
If you are a UK business engaged in R&D, it is worth exploring the possibilities of making an R&D tax credit claim to help support your company's innovative activities.
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