In the ever-evolving landscape of business and innovation, Research and Development (R&D) plays a pivotal role in driving progress and staying competitive. It's a realm where companies explore the boundaries of what's possible, pushing the frontiers of science and technology. Yet, embarking on this journey often entails significant financial investments, including staff salaries, materials, utilities, and more. This is where the concept of R&D qualifying costs enters the equation, determining eligibility for R&D tax relief. In this blog post, we'll delve into the world of R&D expenditures, exploring the expenses they encompass, what doesn't qualify, and how understanding them can be a game-changer for businesses seeking to innovate and thrive in the modern marketplace.
What are R&D qualifying costs?
Carrying out research and development endeavours involves certain expenses also known as Qualified Research Expenses (QREs); creativity and innovation unfortunately come at a price. Essentially, companies need to pay staff and invest in machinery. The purpose behind the R&D tax relief incentive is to offset these costs, so businesses can make great leaps ahead in solving technological and scientific uncertainty without being held back. These R&D costs accumulate as R&D activities are carried out in the process of experimentation while attempting to enhance the performance, reliability, quality, and functionality of a product, or solution.
What costs qualify for R&D tax credits?
To ensure you receive your complete funding entitlement from R&D tax credits, it's crucial to accurately recognise all your eligible expenses with documentation, and incorporate them into your claim to HMRC. Knowing what does and doesn’t qualify as R&D costs maximises the chances of success from your claim and prevents time-consuming enquiries from HMRC. Let’s break down the R&D qualifying costs:
Staff costs
You can claim for direct staff costs for the work completed on R&D. This is applicable for both R&D tax credits for SMEs and larger companies claiming under RDEC. This covers:
- Total employee salaries (covering wages, overtime earnings, and cash bonuses)
- Contributions made by the employer for National Insurance (NI)
- Employer contributions toward pension plans
- Specific business expenses that have been reimbursed
To calculate how much you can claim for staff costs you need to first calculate the total of the above list for each employee who worked on your R&D project. Multiply this figure by the proportion of time they spent working on R&D during the year. So, say one employee costs you a total of £35,000 and they spent 75% of their time working on your R&D project, you can include £26,250 on your claim for this employee.
R&D subcontractor costs
Many R&D projects involve outsourcing pieces of work to external subcontractors based on the scope and technicality of the work. The eligible expenses for incorporation when it comes to subcontractors vary between the Research and Development Expenditure Credit (RDEC) scheme and the SME R&D tax credit scheme.
Subcontracting under the SME scheme
The subcontractor doesn’t need to be situated in the UK and there is no requirement for the subcontracted R&D to be performed in the UK. The actual work carried out by the subcontractor need not be R&D when looked at in isolation. You can claim R&D tax relief for 65% of the payment you paid to the subcontractor. The subcontractor is not obligated to carry out the work itself and can instead delegate it to a third party.
Subcontracting under RDEC
The regulations differ for claiming subcontractor costs under the Research and Development Expenditure Credit (RDEC) in comparison to the SME scheme. This is because larger companies can claim 100% of the amount they paid. However, you can only claim for expenditure for subcontracted work if the subcontractor is one of the following:
- Being an individual
- A partnership of individuals
- A charity
- A higher education institute
- Research organisation
- Health service body
Costs for externally provided workers (EPWs)
An EPW is an externally provided worker in relation to the claimant company. HMRC classifies an individual as an EPW if they are not a director or employee of the company, they provide services to the company while subjected to supervision and direction by the company as they carry out the services. Just like the percentage for subcontractor costs, SMEs can claim 65% of the payment they made to EPWs. This is the same for RDEC too.
Cloud computing and data costs
One of the changes made to R&D in April 2023 was the inclusion of cloud computing and data costs as part of eligible R&D costs. The aim of expanding the list of R&D costs was to better support research methods of businesses across the UK who are increasing their cloud storage and ware using large amounts of data. You can now claim for:
- Licence payments for datasets
- Cloud computing costs that can be attributed to computation, data processing and software
These costs must be associated with activities that directly relate to research and development; contributing to a scientific or technological uncertainty.
Clinical trials
In the pharmaceutical sector, you have the opportunity to seek reimbursement for payments made to participants involved in clinical trials as part of your R&D projects.
Materials and consumables
You can claim back expenditure for consumable items under the government's R&D tax credit incentive. By consumables, we mean the transformable items of your project such as water, fuel, and power. Typical instances of consumable items used in R&D encompass materials used in building prototypes or for experimentation purposes.
HMRC writes: “The consumable items must be consumed in activity that constitutes R&D for tax purposes, which includes ‘qualifying indirect activities’.”
So additional costs for consumables such as marketing or improving the aesthetics of your project, cannot be included in your R&D claim. This becomes slightly more complicated when calculating utility R&D costs because you can only claim the portion of utility directly associated with your R&D activities. So if you have a dedicated room for R&D work, you can only claim for the utilities associated with heating, air conditioning or lighting in that room.
Software purchases
Another R&D cost you can claim is software purchases. If any software was acquired exclusively for R&D purposes, you are eligible to include its entire cost in your claim. However, if the software serves a dual purpose and is only partially used for R&D, the price must be divided based on the proportion of its usage that is related to R&D activities.
What costs don’t qualify for R&D tax relief?
R&D tax credits are specifically intended to assist companies engaged in trial and error for innovations and advancements by removing the natural pressure that comes with costs. This implies that expenses related to the production, distribution, or creation of goods and services resulting from R&D work cannot be claimed. Examples of ineligible costs include rent, land, patent creation and the distribution of goods and services.
Capital expenditures
The funds you spend on acquiring, improving, or maintaining long-term assets like property, equipment, and technology are not eligible. These expenses are usually handled separately as part of depreciation or amortisation over time.
Costs related to clerical & maintenance work
R&D tax credits typically exclude costs associated with the regular production or manufacturing of existing products. These credits aim to encourage the development of new or improved products, processes, or technologies.
Rent and rates
You cannot include the cost of renting the premises where you conducted the R&D work in your claim. Only the utilities and materials used within that premises are eligible for reimbursement, provided they were used in R&D endeavours.
Patent and Trademarks
While patents and trademarks represent crucial intellectual property assets, businesses often classify the costs of acquiring or protecting them as legal or administrative expenses rather than direct R&D expenditures.
Production and distribution costs
R&D tax credits typically exclude costs associated with the regular production or manufacturing of existing products. These credits aim to encourage the development of new or improved products, processes, or technologies.
How do you track R&D costs?
If you want to secure your full funding entitlement, you need to make sure you identify all of your eligible costs, apportion them correctly, and include them in your claim. We encourage you to maintain thorough documentation of your entire project, to simplify your claiming process. Our R&D Tax Credit Claim Template can also be a useful resource for tracking your R&D costs in one centralised place. Alternatively, for an instant estimated figure of your R&D qualifying costs, try our free R&D tax credit calculator.
Key takeaways
In conclusion, understanding which costs qualify for Research and Development (R&D) incentives is paramount for businesses seeking to harness the benefits of innovation-driven tax relief. Knowing the R&D qualifying costs guide your business decisions and financial decisions as part of your R&D project. By creating a habit of diligent documentation, you can unlock the true value of the R&D incentive as a reward for fostering technological and scientific advancement within your industry.
How can Alexander Clifford help?
If you’re not 100% sure which of your costs you can count as R&D costs, then get in touch with the trusted choice for R&D tax credits, Alexander Clifford. Our professional advice makes all the difference in the R&D benefit you receive. We’ve already retrieved over £83 million for our clients and now it’s your turn!
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