R&D Tax Relief is a government-led tax incentive scheme for UK businesses conducting innovation. Any business working on bringing a new product, process, or service to market (or enhancing existing ones) can take advantage of this scheme by filing an R&D Tax Credit claim.
An R&D Tax Credit claim allows a business to recover up to 27% of the money they’ve spent on qualifying R&D expenditure, either in cash or in the form of a Corporation Tax (CT) deduction.* And best of all - you can claim R&D Tax Credits year after year.
How beneficial could R&D Tax Relief be for your business? And how much could your R&D claim return?
The main determiner of your R&D claim size is how much money you’ve spent on areas that HMRC class as ‘qualifying R&D expenditure’.
Categories of qualifying R&D expenditure, for the purpose of R&D Tax Relief, are as follows:
Externally Provided Workers (EPWs)
Payments to the subject of clinical trials
In this blog, we’re going to be focusing on the second area of qualifying R&D claim expenditure – Subcontractors. We’ll break down the specific inclusions of this spending category to help you assess the scope of your potential R&D claim.
Our previous blog took a closer look at the first category of qualifying R&D expenditure - Staffing. To learn more about which staffing costs can be included in an R&D claim, read our related blog; Claiming R&D Tax Credits for Staffing Costs.
Your R&D Tax Relief Scheme affects your R&D claim size
Claiming R&D Tax Relief for costs incurred through subcontractor (or externally provided worker) activity depends on the R&D Tax Relief scheme you file under, as well as your relationship with said subcontractor.
Firstly, let’s distinguish between the two R&D Tax Relief schemes – SME and RDEC.
The more conventional R&D Tax Relief scheme is called the SME Scheme. To qualify for R&D Tax Relief under the SME scheme, companies must have:
Less than 500 employees;
Less than €86m in gross assets;
Achieved less than €100m in turnover.
The SME R&D Tax Relief scheme allows loss-making businesses to reclaim 27% of qualifying R&D costs (as a cash benefit) and profitable businesses to reclaim 21.5% of qualifying R&D costs (as a corporation tax credit).
If the claimant’s business exceeds the metrics of an SME R&D Tax Credit claim, they’ll have to claim through the RDEC R&D Tax Relief scheme instead. The RDEC Scheme is accessible for large businesses with:
More than 500 employees;
More than €86m in gross assets;
Over €100m in turnover.
Unlike SME R&D Tax Relief, the RDEC R&D Tax Relief Scheme allows businesses to reclaim a fixed rate of 20% of eligible R&D costs (subject to corporation tax). All RDEC applicants will receive their R&D claim as a corporation tax deduction against current or future tax liabilities.
Subcontractor costs can be included in your SME R&D claim
For R&D Tax Credits filed under the SME Scheme, you can include up to 65% of costs allocated to subcontractor activity - if the subcontractor is classed as ‘unconnected’.
Connected parties are where two companies are controlled by the same person, or are in the same group. If you’re connected with your subcontractor, then the claim will be for the lesser of the R&D payment made to the subcontractor and the relevant expenditure of the subcontractor.
Subcontractor costs can be included in your RDEC R&D claim
The costs that you can include for subcontractors within an RDEC R&D Tax Credit claim differ from that of an SME R&D Tax Credit claim. Large companies claiming R&D Tax Relief under the RDEC scheme are only able to reclaim subcontractor costs if payments are made to:
A partnership of individuals
A higher education institute
A scientific research organisation
A health service body
If your project has incurred subcontractor costs that meet one of these definitions, you can include 100% of your annual subcontractor expenditure in your RDEC R&D Tax Credit claim!
Externally Provided Worker (EPW) costs can be included in your R&D claim
Aside from subcontractors, an R&D Tax Credit claim also allows businesses to reclaim costs spent on Externally Provided Workers (EPWs).
But what’s the difference between subcontractors and EPWs?
A subcontractor provides services for the contractor, whereas an EPW provides labour with supervision, direction and control remaining in the hands of the business.
An EPW is paid via invoice from a staff provider as opposed to being an employee on your payroll. EPWs are defined by the involvement of a third-party staff provider alongside the individual.
Again, there are rules around the inclusion of EPW costs in an R&D Tax Credit claim, depending on the R&D Tax Relief scheme you are using, and the relationship you have with the EPW.
Under the SME R&D Tax Relief Scheme, you typically cannot include the full cost of the agency fee for work undertaken by an EPW within your R&D claim. Instead, 65% of the EPW-related expenditure can be included in your proposed R&D Tax Credit claim.
If you are ‘connected’ with your EPW, there is no 65% cap. Alternatively, you can claim R&D Tax Credits on either the EPW costs made to the EPW agency, or the actual cost of labour to the EPW provider - whichever is the lower amount.
Large companies filing an R&D claim under the RDEC Scheme can also claim back EPW expenditure. Like the SME R&D Tax Credits scheme, only 65% of the incurred costs can be included in the R&D Tax Relief report.
That covers the basics of how R&D Tax Relief calculation works in terms of reclaiming subcontractor and EPW R&D expenditure.
Clearly, there are important decisions to be made around whether your R&D work was completed by a subcontractor or an EPW, and whether the individual is connected to your business.
Mischaracterizing any party involved in your R&D project can result in inaccurate R&D claim calculation, HMRC enquiry, and in some cases - financial penalties.
It’s more important than ever to ensure that your R&D Tax Credit claim adheres to HMRC’s rigid guidelines and maintain full compliance.
The only way to do this is by calling upon an experienced R&D Tax Relief Specialist to complete the entirety of your R&D Tax Credit claim.
To learn more about our market-leading R&D Tax Credit service, reach out to our team.
*These are the updated figures in line with the new legislation announced in the April 2023 Spring Budget.