With many of the organisations that we work with, the range of R&D work that is being carried out is typically more complex, comprising 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 or outsourcing elements of expenditure to other ‘connected parties’
Whatever form the 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 the business.
There’s a lot more work to do to ensure you’re not going to under-claim or over-claim, and filing with 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 level of qualifying expenditure, and not where the R&D work was conducted.
In instances where the UK operations form part of a larger international business the treatment of R&D expenditure can be more complex. In certain instances there may be opportunities to recoup costs incurred within other parts of the group’s international operations, but this is typically less straightforward, and will depend on the corporate structure and the contractual arrangements between group companies. These are typically arrangements that would need to have been in place contemporaneously, and cannot have been applied retrospectively. It’s in instances such as this that it is advantageous to look at how the organisation’s R&D activities should best be structured on the basis of professional advice before the commencement of the project. This will ensure that expenditure, which could potentially qualify for R&D tax relief, is not conducted outside of the bounds of HMRCs scheme. 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 arise with claims for businesses operating 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 Research and Development Expenditure Credit (RDECs) to other members of the group, and the activities of both companies have to be taken into account when deciding if the project qualifies.
As far as partnerships are concerned, it’s commonly observed that partnerships 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. 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 companies carry out research and development as part of a joint venture agreement, they may still claim R&D tax credits but, once companies start building ties such as groups and partnerships, the tax situation can become complex very quickly.
LLPs were once seen as being a particularly tax efficient structure, however over recent years changes have been applied to the way LLPs are taxed, and new rules regarding salaried members and corporate members mean this is unlikely to still be the case, particularly if the LLP in question is carrying out activity which would otherwise qualify for R&D tax relief.
Tax On Subcontracted R&D Work
In the case that you subcontract your research and development work completely, rather than shifting it around departments or to another country, you may qualify for tax relief on some or all of the payment.
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. A company requiring skills that can only be found in a handful of global locations, or taking advantage of international cost efficiencies by subcontracting R&D activity to companies in Central and Eastern Europe or Latin America, is still able to take advantage of R&D tax relief, provided a scientific or technological advance is still being sought.
There is a distinction worth highlighting here, relating to whether the company being contracted to carry out R&D activity is under the control of the company subcontracting out the work, in which case they would be viewed 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 scheme, 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, 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 first verify whether what looks like subcontracted R&D fits with HMRCs definition. Incorrect identification and treatment of R&D expenditure can easily lead to the claimant attempting to claim more or less money under the scheme than they are entitled to. Any claims received by one of HMRCs 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, and 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 in 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 participants, with each 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, and as such 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 relief. 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 can seem almost baffling. R&D tax relief claims are an area where you will always typically benefit from the services of a experienced company that’s handling R&D claims day in, day out. 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.