Can My Client Claim R&D Tax Credits For Subcontractor Costs?
The short answer is yes, they can. If your client is an SME that has carried out research and development (R&D), they can typically claim 65% of the costs incurred on subcontractors undergoing eligible R&D activities. For businesses that are applying for R&D Tax Credits using the RDEC scheme, subcontractors must be individuals, partnerships of individuals, or a qualifying body in order that the expenditure is eligible.
Subcontracted R&D work essentially involves a company paying someone else to carry out innovative activities on its behalf. The subcontractor doesn’t have to be a UK resident (for the purposes of an R&D tax relief claim at least), and the R&D work itself also does not have to be UK-based. Furthermore, the R&D works carried out by the subcontractor don’t have to be R&D itself when considered in isolation. However, it should make up part of a larger R&D project plan.
What exactly is the relationship between contractors and subcontractors with regard to R&D Tax Credits?
The type and nature of the working relationship between contractors and subcontractors is something that needs to be carefully considered in a claim for R&D tax relief. For example, your clients should ask themselves what the specific work was that looked to resolve the technical/ scientific uncertainty. They should also consider who exactly carried it out, where and when.
In any case, it’s essential that your client is careful that the expenditure they are claiming for is all in relation to eligible R&D activities. They should think about:
Your client’s company should be undergoing a specific R&D project and contracting out a clearly defined portion of that work to the subcontractor. It should therefore be the case that your client has effective knowledge around the area of development and has created a detailed plan of work required.
If there is a high level of supervision coupled with a very low level of autonomy, the relationship may not be classed as subcontracting - in fact the ‘subcontractor’ may actually be defined as an externally provided worker (EPW). If an SME is subcontracting eligible R&D activities, they will have a vested interest in it, however the subcontractor should still have a decent amount of autonomy in addressing the R&D uncertainties.
With subcontracted R&D, subcontractors are being paid for the R&D work they do - regardless of whether the project is ultimately successful or not. It should therefore be expected that any over running or failure of the project as a whole is the responsibility of the principal company and not the subcontractor.
Intellectual property (IP)
If your client’s R&D work is subcontracted, it is generally the case that the principle company will retain intellectual property rights. However, this area in itself can be complex and isn’t always conclusive to relationship status. Only once your client has considered this criteria and confirmed that they are definitely subcontracting eligible R&D work can it then be included in any claim for R&D Tax Credits.
How much can be claimed for subcontractors in an SME R&D Tax Credit claim?
SMEs are able to claim a maximum 65% of the costs paid to a subcontractor for R&D if the subcontractor is not connected to the company. Connected businesses (where two companies are controlled by the same group or person) should claim for the lesser of the R&D payments made to the subcontractor and the subcontractor’s applicable expenditure.
How should subcontractors be treated when making an RDEC claim?
The costs your client can include for subcontractors will differ depending on whether they are applying via the SME R&D Tax Credit scheme or the RDEC one. Larger companies (and certain SMEs) which are doing so using the RDEC scheme can only submit subcontractor costs if payments were made to specific set-ups. These are:
- A partnership of individuals
- Higher education institutes
- Health service bodies
- Scientific research organisations
If your client has incurred subcontractor costs to a person or organisation mentioned in the list above, they are able to include 100% of their expenditure in an RDEC claim.
What other costs can be claimed in an R&D Tax Credit application?
UK companies can claim R&D Tax Credits on applicable revenue expenditure, that is operational costs day-to-day. However, capital expenditure (payments regarding fixed assets such as buildings and land) usually doesn’t qualify for R&D tax relief.
Qualifying R&D expenditure
The following types of revenue expenditure can be included in an R&D tax relief claim, along with subcontracted R&D:
- Staffing costs (for example salaries, certain reimbursed expenses and employer’s NICs and pension contributions)
- Some types of software
- Externally Provided Workers (EPWs) - this could be freelancers for example
- Payments to anyone taking part in clinical trials
Additionally, larger companies are allowed to include contributions to individuals, groups or specific research organisations that have undertaken qualifying R&D activities.
What's meant by “consumables”?
In terms of an R&D Tax Credit claim, consumables are basically anything that is transformed or used up in the process of an R&D project. Usually this would be things like fuel, heating, power and water. A company’s expenditure on any materials transformed or consumed in the R&D process can also be included in an R&D tax relief claim. For example, applicable materials could be construction prototypes or materials used in testing.
Once the work to resolve the specific scientific or technological uncertainty is complete, any additional costs in the way of consumables (such as materials used in fine-tuning a product or in marketing it) are not allowed as part of a claim. Your client should therefore again be careful to only include consumable costs which were the direct result of their R&D work only. This is likely to differ from their consumable costs for the whole developed product, service or process.
Try the Tax Cloud platform
Find out more about R&D Tax Credits and whether your client might be eligible on the Tax Cloud website. Designed and developed by R&D experts Myriad Associates, there’s a section specifically for accountants which can help you navigate the R&D tax relief claims process. There’s a handy calculator too, so you can see exactly what your client could claim.
We are a team of R&D tax experts, specialists and accountants, ready to assist with any aspect of your client’s R&D Tax Credit claim. Call us today on 0207 118 6045 or use our contact form and we’ll get back to you.