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Using external resources for Research & Development - Do your research first

24th May 2010
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By Denise Montes

The Research and Development (R&D) enhanced tax relief is widely welcomed as an incentive to invest in new ideas and innovative solutions. However, the complexities surrounding the rules can often act as a deterrent from claiming the enhanced reliefs available.

Two particular areas of the legislation which cause confusion are subcontracting and contracts for external workers. There are different rules on whether tax relief is available to aspects of a project which may not have been undertaken by in-house personnel, and this blog aims to explore these differences.

Subcontracting or contracting for staff - clearing up the confusion
Many projects involving R&D will involve the use of external resources, in particular firms or individuals with specific knowledge or experience of the type of project that is being undertaken. The manner in which external resources are used can have a significant impact on the R&D relief available and therefore is well worth looking into from the outset.

Where there is a contract between persons for R&D activities to be carried out by one for the other, then the R&D activities have been subcontracted. A contract for staff results from the inclusion of a staff provider acting as an intermediary and responsible for providing the external workers.

Let us consider each of these arrangements in turn:

Subcontracted expenditure
Where one company engages another company to carry out R&D activity on the first company’s behalf in exchange for payment then that is subcontracting of the R&D to the second company. It is important to be aware that R&D tax relief for subcontracted work is only available to SMEs. Large companies are not entitled to claim for work that is subcontracted to others. The decision of whether to subcontract or use externally provided workers is therefore an all or nothing decision for large companies, although regrettably tax is often not a key consideration at the project decision stages.  

Assuming the project is eligible for R&D relief, the eligible costs for R&D purposes of subcontracted work are limited to 65% of the total cost paid to the subcontractor where the subcontractor and the claimant company are not connected. If they are connected or if they elect to be connected, the whole of the cost is eligible for relief but limited to the total relevant cost incurred by the subcontractor.

Where connected, the claimant company can claim the lower of:
• the qualifying payment that it makes to the subcontractor; and,
• the amount the subcontractor includes as relevant expenditure in its accounting periods ending not more than 12 months from the end of the accounting period in which the payment was made.

In many cases, an election to be connected is not submitted. This can be due to reticence on the part of the subcontracted company to share sensitive information, or it may be deemed administratively burdensome to review all of the costs in detail instead of taking a high level percentage approach. However, the latter problem can be avoided where the claimant company is proactive at the outset of the project in specifying the information to be recorded, and the nature of eligible costs for R&D.

Externally provided workers and tripartite arrangements
Where contracts are in place between the claimant company and staff provider AND between staff provider and externally provided worker, this would be a contract to provide services and not subcontracting.

Where a firm has contracted for services, (i.e. employed external workers) there are further criteria to fulfil in order to be able to claim R&D relief on the expenditure. The tripartite arrangement test is one which often causes confusion, though is relatively straightforward in principle. The tripartite arrangement is based on an arrangement between the firm in question, the staff provider and the worker. Where a personal service company is inserted between the worker and staff provider, the costs in connection with this worker will not be eligible for R&D relief. There are further criteria to meet under tripartite agreements, and it can certainly be time-consuming on large projects to track externally provided workers to ensure they qualify under the scheme.

If qualifying, then, for unconnected staff providers, 65% of the expenditure paid to the staff provider for the supply of externally provided workers is potentially eligible to be treated as qualifying expenditure. As with subcontracted expenditure, the claimant company can jointly elect with the staff provider to be treated as connected.

In reality, contractual arrangements are often created with different clauses for external resources for different phases of a project, making the determination on whether a firm is subcontracting or using externally provided workers unclear, especially when considered alongside secondments, joint ventures and other common arrangements. In summary, therefore, establishing whether a company’s operations will qualify under the definition of R&D is only part of the issue.

This blog has discussed the areas of subcontracting and external workers only. It is essential for companies who are involved in contracted R&D to review their position to ensure that they are capturing all qualifying payments made in order to maximise the R&D tax claim. In particular, given the recent HMRC guidance material update resulting in qualifying indirect activities being eligible for R&D relief, it is important to ensure that all companies involved have an understanding of R&D relief. In making a claim, it is also necessary to ensure that detailed documentation is in place to substantiate the claim. This can be difficult if tax is not considered at the outset or even during the project, but there is no doubt that in many cases the tax benefits will substantially outweigh these administrative costs in association with the documentation process and information gathering.

Denise Montes is a senior consultant Bourne Business Consulting LLP, specialising in asset taxation and advising clients in the retail, real estate, pharmaceuticals and financial services sectors.


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