How Do Capitalised Costs Work With R&D Tax Relief Claims?
Capitalised costs and how they related to R&D tax relief can be a minefield even for the most experienced of accountants.
To capitalise or not to capitalise
Here at Tax Cloud both our clients and partner accountancy firms often ask about capitalised costs and how they relate to R&D Tax Credits. It can be a little complex, so it’s not surprising there’s some confusion. Here we look at how it all works in more detail.
Why do businesses capitalise expenditure?
As an established accountant you’ll likely be aware about how capitalised expenditure works. However, in the interests of clarity, we’ll go in at ground level as a refresher.
Essentially, capitalised expenditure costs are depreciated (or amortised) on the balance sheet, to reflect the fact that the business has benefited from them over several years. So your client’s income statement will show a depreciation expense in each year the asset exists in a useful form, instead of one large expense in the year of purchasing. This means the organisation’s profits for the year accurately represent its financial situation.
Tangible assets include fixtures, fittings, warehouses and other buildings. However, such assets could also include non-physical items like an ERP system. These should be treated on the balance sheet in the same way.
R&D queries and the CIRD manual
The CIRD manual is HMRC’s bible when it comes to all things R&D tax. It’s the go-to source of information for businesses and their accountants alike, outlining in detail the accepted rules around every area of R&D.
However, the CIRD is updated regularly as legislation and guidance are updated (which is why partnering with an external R&D tax consultancy like Myriad Associates is so worthwhile).
However, the CIRD can also muddy the waters a little. For example, CIRD81700 states that to qualify as R&D expenditure, a cost must be allowable as a deduction when calculating trading profits. Therefore it appears that capital expenditure is excluded.
Ok that sounds fine, and many clients and advisers will reach the conclusion that any expenditure entered on the balance sheet cannot then be subject to R&D tax relief. Indeed, it seems perfectly acceptable to draw this conclusion; except for unfortunately this isn’t quite right. This is because, later on in the CIRD81700 rules, it states that the accounts treatment (regarding either writing off expenditure immediately to the P&L account or including it on the balance sheet as an asset) does not determine whether a piece of expenditure is capital or revenue for the purposes of tax.
The big hint to take from this is that when a cost is capitalised, it doesn’t automatically mean the expenditure is capital for tax purposes. And, if indeed it isn’t capital for tax purposes, it may therefore be subject to R&D tax relief.
All is not lost however, as CIRD81700 then links off to a new section of the manual - CIRD81450. This makes the situation clearer around capital costs in the accounts that are actually classed as revenue for the purposes of tax.
CIRD81450 sets out three requirements regarding expenditure to be included in an R&D tax relief claim which have been subject to capitalisation in the accounts. Briefly, these are:
- The expenditure must be an allowable cost when calculating the taxable profit for the period in question
- The expenditure must be an intangible (as opposed to tangible) asset in the accounts
- The expenditure should actually have been incurred during the period in question.
If all three of these criteria are met, then there’s nothing to say that an expense shouldn’t form part of a claim for R&D tax relief. This is of course assuming it’s an eligible cost. Another important thing to bear in mind is that if full relief is applied to the entire cost in the year it was incurred, any amortisation subsequently of the asset in the accounts must be disregarded for later tax relief claims. This is due to the fact that the organisation will have benefitted from full tax relief in the year the expenditure was made, so any future amortisation of the asset for tax reasons would essentially mean ‘double claiming’. Which of course is not permitted.
How are capitalised costs typically included in an R&D tax relief claim?
For practical purposes, the following costs are usually capitalised (as an intangible fixed asset) before then being included in a claim for R&D tax relief:
- Staff costs that were incurred on a specific R&D project which have been capitalised
- Certain capitalised software costs which were made as part of an eligible R&D project
- Capitalised subcontractor costs which were made as part of an eligible R&D project
Our team would be happy to advise you on this where required. Get in contact.
How the Tax Cloud portal makes for easier, faster R&D Tax Credit claims for your clients
The brainchild of R&D tax and funding consultants Myriad Associates, the Tax Cloud portal was launched back in 2017. It’s designed to make claiming R&D Tax Credits easy, allowing businesses and their accountants to follow the fully guided steps to put an application together. So not only are you helping your clients claim the essential relief they deserve, you’re also building your customer base and reputation by diversifying your services.
The system allows you to work through your client’s claim at your own pace, and as it’s cloud-based it’s accessible from any internet-connected device 24/7. Our technical specialists and advisors are also available at every stage to offer advice, and Tax Cloud even integrates with Xero too.
Looking for additional advice around how capitalised costs work with R&D tax relief?
It’s a complex subject and can be a massive headache even for the most experienced of accountants. So if you would like to know more about anything we’ve raised in this article, or about claiming R&D tax reliefs in general, please do call our expert team on 0207 360 4437 or send us a message. It’s also well worth reading through our previous blogs for accountants on similar subjects: