However, for many of the organisations that we work with, the range of R&D work that is being carried out is typically more complex. It comprises of R&D projects that are being carried out internally, subcontracted to third party companies, outsourced to freelance developers, or carried out by an organisation’s international offices operating overseas.
Complexity tends to arise where a company is:
- operating transfer-pricing agreements amongst group companies,
- cross-charging elements of expenditure between different companies within a group structure
- outsourcing elements of expenditure to other ‘connected parties’
Whatever form your organisation’s R&D projects may take, it’s important to bear in mind that the different treatments applied depend on how and where the expenditure has been incurred. If the correct treatment is not applied then this can lead to under-claiming or over-claiming R&D expenditure incurred by your business.
There’s a lot more work to do to get the claim right. Filing a questionable narrative or technical report can open the door to unwelcome and time-consuming scrutiny from HMRC.
When you compare claiming for in-house R&D with what happens when your R&D is carried out elsewhere though, it’s clear that many more complications are added.
Tax on overseas R&D work within your company
If research and development activity is carried out by a division of a UK-based company, but this division is based overseas, it could still be eligible for R&D tax relief. This is assuming that your overseas branch is a permanent establishment, whose activities are within the scope of UK Corporation Tax.
The most important thing to remember is that there is no limitation on R&D tax credits or R&D tax relief based on geography. Whether you can claim is based on your qualifying R&D activities and the level of qualifying expenditure – not where the R&D work was conducted.
If your 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 your group’s international operations. However, this is typically less straightforward, and will depend on your corporate structure and the contractual arrangements between group companies.
These are typically arrangements that would need to have been in place contemporaneously, and cannot be applied retrospectively. In cases like this, it is advantageous to take professional advice on how your organisation’s R&D activities should best be structured before the project begins.
This will ensure that expenditure, which could potentially qualify for R&D tax credits, is not conducted outside of the bounds of HMRC’s rules. Corporate structures that have been implemented solely with the purpose of taking advantage of tax incentives are unlikely to be viewed favourably by HMRC.
What about groups and partnerships?
Other complications can arise if your business operates as part of a group. If a company surrenders its losses to another company, or vice-versa, that is generally indicative that your company is taxed as a group.
Under the large company scheme, if one company within a group contracts another to carry out its research and development work, additional rules apply. You may, for instance, surrender your Research and Development Expenditure Credit (RDEC) to other members of the group. The activities of both companies must be taken into account when deciding if the project qualifies.
As far as partnerships are concerned, they cannot claim R&D tax relief. In this sense, we are referring to Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs), as they are not registered for UK Corporation Tax.
LLPs were once seen as being a particularly tax efficient structure. However, over recent years, changes to the way LLPs are taxed, and new rules regarding salaried members and corporate members, mean this is unlikely to still be the case. This is particularly so if the LLP in question is carrying out activity which would otherwise qualify for R&D tax credits.
While this is true for LPs and LLPs, it’s not the whole story for companies that are carrying out R&D activity as part of a joint venture (JV) partnership.
If your company carries out research and development as part of a joint venture agreement, they may still claim R&D tax credits. However, once companies start building ties such as groups and partnerships, the tax situation can become complex very quickly.
Tax on subcontracted R&D work
When you subcontract your research and development work out of your organisation completely, you may still qualify for R&D tax credits.
For an SME, a subcontracted R&D project doesn’t have to take place in the United Kingdom. The subcontractor doesn’t even need to be based in the UK.
Do you require skills that can only be found in a handful of global locations? Or are you taking advantage of international cost efficiencies by subcontracting R&D activity to Central and Eastern Europe or Latin America? You are still able to take advantage of R&D tax credits, provided a scientific or technological advance is still being sought.
There is a distinction to highlight here. If the company being contracted to carry out R&D activity is under the control of the company subcontracting out the work, they are classified as ‘connected’. If the companies are under the control of separate entities then they would be viewed as ‘unconnected’.
Any elements of R&D expenditure subcontracted to other organisations are likely to restricted under the incentive. But the level of restriction depends on the ‘connected’ or ‘unconnected’ status of the two parties. In some circumstances, it is necessary to look in detail at the costs of the two companies. You would need to demonstrate how the company subcontracted to carry out R&D activity has incurred expenditure related to the delivery of the R&D project.
Is it really subcontracting?
Before claiming for subcontracted R&D work, it is important to verify whether what looks like subcontracted R&D fits with HMRC’s definition.
Incorrect identification and treatment of R&D expenditure can easily lead to you attempting to claim more (or less) money under the scheme than you are entitled to.
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 for their claim. This could subsequently lead to an HMRC investigation or enquiry into the validity of the claim.
When some of the research is carried out in-house, some is carried out at another company, and both of you benefit from the results of the project, it is classed as collaborative research.
In this instance, the amount of expenditure each company incurred on the project is evaluated. R&D tax relief can be claimed by both parties, with each claiming against their own levels of qualifying expenditure.
Externally provided workers
Externally provided workers don’t count as subcontracted R&D. So, 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 your qualifying expenditure. Therefore you can still qualify for R&D tax relief on money spent directly on externally provided workers.
If an individual is simply providing you with a consultancy service, then the costs associated with engaging the consultant to provide services would be unlikely to qualify for R&D tax credits. If a consultant is contracted to carry out work related to the R&D activities, then you should speak with an R&D specialist to see if their costs could potentially qualify.
Still have questions?
Still have questions? Want to check if your grants conflict with your R&D spend or whether you’re part of a significant South West tech cluster? If you’re looking for professional advice, get in touch to see if we can help.
It’s a complex area, and particularly if you’re not from a taxation background may seem baffling.
R&D tax credit claims are an area where you likely to benefit from the services of an experienced company that’s handling R&D tax credit claims day in, day out. With one of the largest teams of chartered tax advisers specialising in R&D tax credits in the UK, ForrestBrown are leaders in this field.
Knowing the correct treatment for different elements of expenditure, and how to communicate this to HMRC is crucial. Relatively minor errors can make tens of thousands of pounds of difference to your potential claim value, and could even result in the claim being rejected. Our award-winning process protects you from this and ensures you get everything you are entitled to. Give us a call on 0117 926 9022 to find out more.