Subcontractor costs and R&D tax relief
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Looking through the questions we’re asked by our clients each month, there are some very clear themes! In fact, four months out of five, the theme of subcontractor costs and how to include these in a claim is close to the top of the list, suggesting that this is something that our clients struggle to get their heads around. To remedy this, here’s our quick guide on subcontractor costs and how they affect R&D tax relief claims.
What do you mean by subcontractor costs?
In this context, subcontractor costs mean any payments made by the claimant company to another entity that has been subcontracted to carry out activities that form part of the claimant company’s R&D project – quite the mouthful! What this means in reality is that any payments made by the claimant company to third parties could be included in an R&D claim, as long as the subcontracted activities relate to the R&D projects.
Great! So I can include all payments made to subcontractors in the R&D claim?
Sadly, it’s a bit more complicated than that! First of all, you need to establish whether the company will be claiming through the SME scheme, the RDEC scheme, or both. This makes a huge difference to the claim, because companies claiming through the RDEC scheme can only claim subcontractor costs paid to qualifying bodies, partnerships or individuals, not limited companies. Companies claiming through the SME scheme, on the other hand, can claim for any subcontractors, and companies claiming through both schemes can only claim the portion of their limited company subcontractor costs related to the SME scheme projects.
Right, I know which scheme my client is claiming through, and I’ve separated out the limited company subcontractors from everything else. What’s next?
Next, you need to establish whether the claimant company and the subcontractor are connected. To do this, you need to look at the ownership of both entities, and look for any people in common, or connections between individuals. For example, if the director of the claimant company subcontracted work from their spouse’s company, you ‘d have to treat this as a connected subcontractor scenario.
Ok, I know which subcontractors I can claim for, and which of these are connected to my client. Can I go ahead and add the costs to the claim?
Yes! However, the next thing to work out is how much of the cost was related to the R&D projects, and how much of it you can include in the claim.
The first key point to remember here is that, under the rules of the SME scheme, for unconnected subcontractors the maximum amount that can be claimed is 65% of the relevant payment made to the subcontractor. For example, a claimant company spends £50,000 on subcontracted testing in the claim year, of which 50% related to the R&D projects. The total they can include in their claim is:
£50,000 x 50% (amount that relates to R&D) x 65% (cap on subcontractor costs) = £16,250
The second key point to remember is that the rules are completely different for connected subcontractors. In this scenario, you can include the lower of either the payment to the connected subcontractor, or the relevant costs of the subcontractor. For example, a claimant company spends £50,000 on subcontracted testing by a connected company in the claim year, of which 100% relates to the R&D projects. The relevant costs of the connected subcontractor are £45,000. The total they can include in their claim is therefore £45,000.
The last key point to remember is that companies claiming through RDEC are subject to the same rules around connected and unconnected subcontractors but can only include payments to the qualifying bodies, partnerships or individuals. They don’t have to restrict these payments to 65%.
Is there any way to avoid the 65% cap on subcontractor costs?
Nope! That’s the rule for unconnected subcontractors, and there are no exceptions to it.
What about raw materials and agency staff? Are these subcontracted costs?
No, these costs don’t count as subcontracted costs, but they can be included under other eligible cost categories. Raw materials should be claimed as consumables, and agency worker costs have a category all to themselves.
After all that, is it worth including subcontractor costs in an R&D tax relief claim?
Absolutely! In our experience, these costs often make up a large proportion of the eligible expenditure, so it’s definitely worth taking the time to bottom out whether your client has incurred any eligible subcontractor costs.