What doesn't qualify for R&D tax relief

Understanding which projects, activities and costs do not qualify for R&D tax relief is as important as identifying those that do. HMRC’s guidance, including the DSIT guidelines and Guidelines for Compliance 3 (GfC3), set out the core conditions, but applying them to real projects and expenditure can be complex. 

This article explains the main exclusions and common areas of confusion to help businesses reduce the risk of including ineligible costs in a claim. 

Find out which organisations and types of businesses don’t qualify for R&D tax relief.

What types of projects or activities don’t qualify

As a basic principle, it is unlikely that you will have eligible costs if your activity is not seeking an advance in knowledge or capability in a field of science or technology. You cannot claim if the advance is in the arts, humanities or social sciences (including economics). 

Eligible projects have to be attempting to resolve scientific or technological uncertainty.  

Some activities, no matter how innovative they are, do not qualify for R&D tax credits. These include:

• Social sciences – for example, psychological studies and surveys on attitudes to a product or service. These may, however, go on to inform other activity that would qualify for R&D tax relief (for example, a project to develop data analytics software).
• Business processes – improvements to the way that your business is run that relate solely to people or cost management rather than technological innovation.
• Marketing – marketing campaigns don’t qualify, although some of the technological projects underpinning them may do.

Within an R&D project, some activities do not contribute to resolving the technological uncertainty and therefore do not qualify. Common examples include:

• Routine analysis and copying: Routine testing, reverse engineering, or copying an existing product/process simply to adapt it does not qualify. However, you can still claim R&D relief for duplicating an existing product, if certain criteria are met. This will usually depend on whether the information about how the original product was developed is readily available, and how you approach the solution.
• Post-uncertainty work: Activities after the technological uncertainty has been resolved, such as cosmetic design, fine-tuning, or marketing trials, are not eligible. Whereas work to improve cosmetic or aesthetic qualities isn’t R&D, they may be considered drivers for R&D. Therefore, work to create these effects through the application of technology may still qualify.
• Internal software (routine): Simply updating a website or creating standard, readily available software functionality is not qualifying R&D. Read more on what qualifies for R&D tax relief in software.

What types of costs can’t be included in an R&D claim

Not all costs associated with qualifying activities are eligible for R&D tax relief. Depending on the accounting period, the relief claimed and the circumstances of the expenditure, qualifying costs may include:

• Staffing costs 
• Subcontracted R&D 
• Externally Provided Workers (EPWs) 
• Consumables 
• Software, hosting and cloud computing costs, and data licencing costs 
• Payments to the subjects of clinical trials

Find out more about what costs qualify for R&D tax credits.
There are project costs that cannot be included such as:

Recoverable VAT

Recoverable VAT is not a cost to the company and cannot be included in an R&D tax relief claim. Irrecoverable VAT may form part of qualifying expenditure where it relates to an otherwise qualifying cost.

Discover more about whether you can include VAT in an R&D tax credit claim.

Capital expenditure on physical assets

The way R&D costs are recorded in your company’s accounts can affect how they are treated for tax purposes.  

Capital expenditure on tangible assets, such as plant, machinery or equipment, is excluded from the R&D tax relief expenditure categories. However, separate R&D allowances may be available for certain capital expenditure on facilities or equipment used for qualifying R&D. 

Find out more about claiming capital allowances.

Expenditure capitalised as an intangible asset may still qualify where it is revenue in nature for tax purposes, falls within a qualifying cost category and satisfies the conditions of the relevant R&D relief. In appropriate cases, the deduction may be made through an adjustment in the company’s tax computation. 

As every company’s position is different, speaking with an experienced R&D tax adviser can help you understand the options and choose the right approach for your business.

Find out more about how capitalised costs and intangible assets can affect an R&D tax relief claim.

Production & distribution costs

R&D tax relief is designed to support work that helps resolve scientific or technological challenges. Costs linked to routine production, delivery and distribution will not usually qualify because these activities generally take place once those challenges have been overcome and the product, process or service is ready for commercial use.

For example, the everyday costs of manufacturing, packaging, warehousing, fulfilling orders, transportation and delivering a finished product or service to customers will not normally qualify for R&D tax relief.

However, scientific or technological challenges can sometimes arise while a business is developing or scaling up a production process, even when it is already producing goods or services for customers. In these situations, it is important to separate the work undertaken to resolve those challenges from routine commercial activity. ForrestBrown will work with you to review the position, identify any qualifying activity and make sure the relevant costs are treated appropriately.

Patents and intellectual property

Similar to the above, costs associated with registering a patent for your innovation and around protecting your intellectual property aren’t qualifying costs. This is because these are seen as post-uncertainty costs. 

Find out more about Patent Box tax relief.

Marketing

R&D tax relief focuses on work undertaken to resolve scientific or technological challenges, rather than the commercial activities used to promote a product or service. Marketing costs such as advertising, branding, public relations, promotional campaigns and preparing sales materials will not normally qualify, even where they relate to a new or innovative product.

Operating costs

Many of the everyday costs of running a business cannot be included in an R&D tax relief claim. These commonly include rent, business rates, insurance, general office costs and routine activities such as administration, finance, human resources, legal support and facilities management.

However, certain costs used directly in qualifying R&D, such as an appropriate proportion of electricity, gas or water consumed during the work, may be eligible. Some administrative, finance or personnel activities may also qualify where they form part of supporting a specific R&D project. The treatment depends on the nature of the cost, how it was used and the activity it supported, so ForrestBrown can help you review the position and identify the costs that may be included in your claim.

Other ineligible R&D project costs

• Staff training costs
• Entertainment and hospitality
• Interest and other financing costs

Overseas expenditure

For accounting periods beginning on or after 1 April 2024, relief for contracted-out R&D and externally provided worker costs is generally restricted where the relevant activities are undertaken outside the UK. Limited exceptions may apply where conditions necessary for the R&D are not present in the UK, are present in the overseas location, and it would be wholly unreasonable to replicate them in the UK. Cost or workforce availability alone is not sufficient. 

For further guidance, see our article on overseas R&D expenditure.

What do I do if these costs have been included in an R&D tax relief claim?

If you believe that you have incorrectly included ineligible expenses in your R&D tax relief claim, then you first need to consider the timings. As the claim is made via your Corporation Tax return, the same filing and amendment windows apply. This means that you have up to two years following the end of the accounting period to amend your Corporation Tax return.  

If the amendment deadline has passed and the company has claimed too much R&D relief, it may need to use HMRC’s R&D disclosure service to correct the position and repay relief or tax credits received in error. Interest will normally need to be considered, and penalties will depend on the circumstances and the behaviour that led to the inaccuracy. The service is not appropriate in every case, including where the original behaviour was deliberate or where there is no Corporation Tax or tax credit to repay, so professional advice should be sought promptly. 

For further information, see our guidance on HMRC penalties for incorrect claims.

When you can’t claim R&D tax relief

There are certain scenarios where you are unable to claim R&D tax relief.

You are not subject to UK Corporation Tax

R&D tax relief is a Corporation Tax incentive, so it is generally available only to companies within the charge to UK Corporation Tax. Filing a Company Tax Return does not, by itself, determine whether a company is eligible, and the position can be more complex for overseas companies or organisations with exempt activities. ForrestBrown can help you confirm whether your company meets this requirement. 

A company does not need to be profitable or have Corporation Tax to pay to make an R&D tax relief claim. Loss-making companies may still benefit, although whether relief results in a payable credit, a reduction in other liabilities or an amount carried forward will depend on the scheme and the company’s circumstances. An R&D tax adviser can explain the options available to your business.

Missed the claim notification deadline

If you were required to notify HMRC but did not submit the notification form, you will be unable to claim R&D tax relief for that period. Unless the three-year exemption applies to your company, your claim will be removed from your Company Tax Return and relief denied regardless of whether your R&D would otherwise be eligible.  

Find out more about claim notification.

Your innovation occurred more than three years ago

R&D tax relief can only be claimed retrospectively for two accounting periods (that’s just under three years at most). 

Unfortunately, even if you did some fantastically innovative work four years’ ago, then you will not be able to claim for it.