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What if R&D occurs elsewhere?

27th Feb 2015
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When an organisation’s research and development activity is done internally, an R&D tax credit claim tends to be relatively straightforward. Many of the cases we see at ForrestBrown however are considerably more complex; comprising R&D projects that, as well as being carried out internally, might be subcontracted to third party companies, outsourced to freelance developers, or carried out by an organisation’s international offices operating overseas.

Things can get complicated when a company is operating transfer-pricing agreements amongst group companies, cross-charging elements of expenditure between different companies within a group structure or outsourcing elements of expenditure to other ‘connected parties’.

Whatever form the organisation’s R&D projects take, consider that the different treatments applied depend on how and where the expenditure was incurred. If an incorrect treatment is applied, this can lead to under-claiming or over-claiming R&D expenditure.

There’s a lot more work to do to ensure a company doesn’t under or over-claim, and filing with a questionable narrative or technical report can lead to unwelcome scrutiny from HMRC. It’s clear, that when R&D is being conducted elsewhere, it can be a far more complicated proposition than an in-house R&D claim.

Tax relief on R&D carried out abroad

If research and development is carried out by a division of a UK based company, but this division is based abroad, it could still qualify for R&D tax relief. This is assuming that the overseas branch is a permanent establishment, whose activities are within the scope of UK Corporation Tax.

Remember this - there is no geographical limitation on R&D tax credits or R&D tax relief. A claim is based on qualifying R&D activities and level of expenditure, not where the R&D was carried out.

Where UK operations form part of a larger international business the treatment of R&D expenditure can be more complex. There may be opportunities to recoup costs incurred within other parts of the group’s international operations, but this will depend on the corporate structure and the contractual arrangements between group companies – more complexity! These are typically arrangements that would need to have been in place at the same time, and cannot be applied retrospectively.

Here it is advantageous to take specialist advice on how the organisation’s R&D activities are structured prior to the project beginning. This will ensure that expenditure, which could potentially qualify for R&D tax relief, is not conducted outside the HMRC scheme. But of course, corporate structures that have been implemented solely with the purpose of taking advantage of tax incentives are unlikely to be viewed favourably by HMRC.

How about partnerships and groups?

For businesses operating as part of a group, other complications can arise with R&D claims. 

Under the large company scheme, if one company within a group contracts another to carry out its research and development work, additional rules apply. For example, Research and Development Expenditure Credit (RDECs) may be surrendered to other companies within the group. Then the activities of both companies have to be taken into account when deciding if the project qualifies.

As for partnerships, it’s commonly observed they cannot claim R&D tax relief. True of course for Limited Partnerships (LPs) and Limited Liability Partnerships (LLPs) as they are not registered for UK Corporation Tax. But what about companies that are carrying out R&D activity as part of a joint venture (JV) partnership?

If companies carry out research and development as part of a joint venture agreement, they may still claim R&D tax credits. However, going down this road can quickly lead to a very complicated tax situation.

LLPs were once seen as being a particularly tax efficient structure. But in recent times changes have been applied to the way they are taxed, and new rules regarding salaried members and corporate members mean this is unlikely to still be the case. Especially if the LLP in question is carrying out activity which would otherwise qualify for R&D tax relief.

How subcontracted R&D is treated

If a company subcontracts research and development work completely it may qualify for tax relief on some or all of the payment.

For an SME, a subcontracted R&D project needn’t occur in the United Kingdom. The subcontractor doesn’t even need to be UK based. As long as the underlying qualifying criteria for an R&D claim are met – for instance, a scientific or technological advance is being sought - a company can scour the globe for the right skillset and still benefit.

One distinction worth highlighting here, concerns whether the company being contracted to carry out R&D activity is under the control of the company subcontracting out the work. In this case they would be viewed as ‘connected’. If not, they would be classed as ‘unconnected’.

Any elements of R&D subcontracted expenditure are likely to be restricted under the scheme, but the level of restriction depends on the ‘connected’ or ‘unconnected’ status. It may be necessary to look in detail at the costs of the two companies, to demonstrate how the company subcontracted to carry out R&D activity has incurred expenditure in delivering the R&D project.

Defining subcontracting

Before claiming for subcontracted R&D work, it is important to check against the HMRC definition of subcontracting. Incorrect identification and treatment of R&D expenditure can easily lead to an erroneous claim. Any claims received by one of HMRC’s R&D units where the claimant has not correctly identified the appropriate treatment for their expenditure is likely to receive additional scrutiny. Perhaps even an HMRC investigation or enquiry into the validity of the claim.

Collaborative R&D

When some research is done in-house and some is carried out by another company, and both companies benefit from the results, it is classed as collaborative research.

Here, the amount of expenditure each company incurred on the project is evaluated and R&D tax relief can be claimed by both participants based upon their own qualifying expenditure.

Externally provided workers

Externally provided workers don’t count as subcontracted R&D. Therefore simply paying another company for their staff’s time does not necessarily count as subcontracted R&D. However, money spent on externally provided workers still counts towards qualifying expenditure. So money spent directly on externally provided workers can still qualify for R&D tax relief but the same restrictions will still apply as if they were subcontracted workers.

Self-Employed Consultants

If an organisation is provided with a consultancy service by an individual, then the costs associated with engaging the consultant would be unlikely to qualify for R&D tax relief. If a consultant is contracted to carry out work related to the R&D activities then it is worth consulting with an R&D specialist to see if their costs could potentially qualify.

Any questions or want to work with R&D specialists?

If you are interested in working in partnership with a specialist R&D Tax Credit Consultancy to deliver increased value to your clients and streamline your own processes, then get in touch with ForrestBrown today. We have a time tested process for working effectively with accountants and it’s mutually beneficial, based on trust and most importantly delivers outstanding results to your clients.

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