If your company has a big development project, you may be capitalising development costs as intangible assets. This has an impact on your R&D tax credit claim, as these costs are treated slightly differently than revenue expenditure that normally makes up your claim.
This guide explains what it means to capitalise R&D costs, how this can be done, and how a specific piece of tax legislation lets you claim the full amount in year one rather than spreading it over several years.
What does it mean to capitalise R&D costs?
When you capitalise expenditure, it sits on your balance sheet as an asset rather than appearing as a cost in your profit and loss account straight away. The cost is then charged to your income statement gradually, over the years the asset benefits your business. For a physical asset like a machine (a tangible asset), this charge is called depreciation. For something without physical form (an intangible asset), like a software platform, it's called amortisation.
Say your business spends £100,000 on staff and subcontractors building an ERP system that you expect to be useful for your business for 5 years. Rather than taking the full £100,000 as an expense in the year you built it, you'd amortise it over its useful life, say 5 years, charging £20,000 to your income statement each year. This better reflects the state of your business’s finances.
What impact do accounting reporting standards have?
Most private UK companies and SMEs report under FRS102, part of UK GAAP. Public companies listed on a stock exchange must use the international IFRS framework instead, so investors can compare financials globally.
FRS102 is used by most UK companies and largely aligns with IFRS but has some changes for jurisdictional differences. When it comes to development costs, companies may recognise them as an intangible asset if certain criteria are met under FRS102. Public companies reporting under IFRS must capitalise their costs if the criteria are met. Essentially, more businesses are capitalising this type of expenditure as an intangible asset under modern UK standards.
What qualifies as an intangible fixed asset?
Regardless of your reporting standard, the company must be able to demonstrate:
- The technical feasibility of completing the intangible asset so that it will be available for use or sale.
- Its intention to complete the intangible asset and use or sell it.
- Its ability to use or sell the intangible asset.
- How the intangible asset will generate probable future economic benefits (e.g., the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset).
- The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
- Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
Under IFRS, entities must also show that future economic benefit from the asset will flow through the entity and the cost of the asset can be measured reliably.
If you meet all of these criteria, you can claim a set of development costs as an intangible fixed asset.
How is a R&D asset's useful life worked out?
The rules differ slightly depending on which accounting standard you use, and this affects how quickly amortisation, and therefore your annual R&D claim, would flow.
- Under FRS102, all intangible assets are treated as having a finite useful life. If you can't reliably estimate it, the useful life is capped at 10 years.
- Under IAS38 (IFRS), an intangible asset can have either a finite or an indefinite useful life. There's no presumed 10-year maximum. Assets with an indefinite life aren't amortised; instead, they're tested for impairment every year.
For most development projects, you'll be looking at a finite useful life and a straightforward amortisation schedule.
What R&D spending could be an intangible asset?
Internally generated R&D spending is split into a research phase and a development phase, and they're treated differently.
- Research expenditure is always recognised as an expense. It can't be capitalised.
- Development expenditure can be capitalised as an intangible asset, but only once it's probable that the asset will generate future economic benefits for your business, and the cost can be reliably measured.
This distinction matters because it determines when capitalisation starts. Work that's still exploratory, before you know whether it will lead to something usable, sits in the research phase and is expensed as normal. Once you're far enough along that a specific outcome is probable and you can reliably measure what it's cost you, that spending typically shifts into the development phase and onto the balance sheet.
The costs that can be included in your intangible assets are basically anything that relates to the development of your project, from staff time to patents. However, there’s an important distinction between intangible assets in general and intangible assets that you can claim R&D tax credits on; only qualifying R&D expenditure can be included in your R&D tax claim. This includes:
- Staff costs
- Externally Provided Workers (EPWs)
- Subcontractor costs
- Software costs, cloud computing costs and data licences
- Payments to clinical trial volunteers
Costs that do not feature in this list (e.g., plant & machinery, legal fees, or even staff and subcontractor time on non-R&D activities) cannot be included in your R&D tax credit claim.
For example, our company developing an ERP solution could capitalise the costs of staff time, subcontractor time and any software licenses they used on this project as an intangible asset (the asset being the ERP solution), so long as these costs relate to qualifying R&D activities.
However, a pharmaceutical company developing a new drug has an expanded list of costs they want to include. They will include the eligible staff, subcontractors and clinical trial payments, but also the amortisation of patent costs, the depreciation of plant & machinery used in development and legal costs for presentation to authorities. These latter costs are not qualifying expenditure for R&D tax credits, therefore must be excluded from their claim.
How does capitalising expenditure affect your R&D tax credit claim?
To include a cost in your R&D tax credit claim, it must meet several legislative conditions, one of which is that the expenditure is deductible when calculating your taxable trading profits. For most day-to-day R&D costs, like staff time or consumables, that's straightforward: you expense them, and they're deductible in the year you incur them.
Capitalised costs work differently. Only the amortisation charge in a given year is normally tax deductible, not the full amount you spent. That means only the amortisation charge would ordinarily qualify for your R&D tax credit claim each year, spreading your claim, and the cash benefit that comes with it, over the life of the asset. This offers a more realistic view of how the business is performing.
Using the £100,000 ERP example: if the platform is amortised over 5 years, only £20,000 would qualify for your R&D claim in year one. The remaining £80,000 would trickle through at £20,000 a year for the next four years.
However, very few companies would choose to claim for amortised costs when the section 1308 provision allows you to accelerate your credit and claim in a single year.
Can you claim the full amount in year one?
Yes – section 1308 of the Corporation Tax Act 2009 allows you to include the full capitalised cost in your R&D tax credit claim in the year you incur it, rather than waiting for it to filter through as amortisation, provided the expenditure genuinely qualifies as R&D and isn't capital in nature.
The total tax benefit over the life of the asset is the same either way; what changes is the timing. For a business relying on R&D credits to fund the next stage of development, that difference in timing is often the whole point. You aren’t required to use section 1308, but most companies elect to, as it gives them the R&D tax credit sooner rather than later.
Using the same example: instead of claiming £20,000 a year for 5 years, you could claim the full £100,000 in the year the expenditure was incurred, provided you meet the conditions. Each year, £20,000 is still deducted when working out your taxable profits, but the full amount is unlocked for your R&D claim upfront rather than staggered.
Important: once you’ve elected to use section 1308 and access your credit in year one, you cannot claim your amortised expenditure when they are later charged to your P&L.
Does it matter whether the asset is tangible or intangible?
Yes, and this is a distinction worth getting right before you file. R&D tax relief is only available where the R&D expenditure begins as a qualifying category (e.g., staff costs, subcontractors…) and has been capitalised as an intangible fixed asset, such as software or a development project.
Where R&D spending has been capitalised as a tangible fixed asset, such as equipment or machinery bought for the project, it's not possible to include that expenditure in an R&D claim at all (although R&D capital allowances may apply).
Key takeaways
- Capitalising R&D costs spreads the accounting expense over the asset's useful life through amortisation, rather than recognising it all at once.
- Section 1308 CTA 2009 lets you claim the full capitalised amount in year one, as long as the expenditure is genuinely R&D and revenue in nature.
- Without action, only the annual amortisation charge would qualify for your R&D tax credit claim each year, delaying access to the full benefit.
- This only works for intangible fixed assets. Expenditure capitalised as a tangible fixed asset generally can't be included in an R&D claim.
- The useful life rules differ between FRS102 and IFRS, which affects how amortisation, and your claim, would otherwise be staggered.
Capitalised R&D costs are one of the more easily missed areas of a claim, particularly if your accounting treatment has changed recently and nobody has flagged the knock-on effect for your tax position. If you'd like help working out how these rules apply to your accounts, get in touch with the Tax Cloud team.
