Can You Claim R&D Tax Credits for Subcontracted Work?
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Subcontracted R&D Work and Tax Relief: A Comprehensive Guide
Subcontracting work for Research and Development (R&D) purposes offers numerous advantages, allowing companies to tap into specialised skills and expertise while enhancing the quality and efficiency of the research process. It also enables organisations to allocate resources more effectively, enabling them to focus on core business functions while outsourcing specific R&D tasks.
While many businesses choose to use subcontractors in their R&D endeavours, there is also a valuable opportunity in the form of receiving R&D Tax Relief for the company seeking subcontracted R&D work. This tax relief serves as a significant incentive for companies investing in innovation, providing support from HMRC (His Majesty's Revenue and Customs) that can result in a substantial reduction in corporation tax or, a valuable cash credit.
In this article, we will delve into the rules and regulations regarding the claiming of tax credits for subcontracted R&D projects.
Can You Claim R&D Tax Credits for Subcontracted Work?
If you are a small or medium-sized enterprise (SME) utilising the SME scheme, you can claim up to 65% of the costs paid to an unconnected subcontractor for R&D activities. Larger companies, claiming under the Research and Development Expenditure Credit (RDEC) scheme, have more specific guidelines regarding the types of subcontractors they can utilise.
Defining Subcontracted Activity for R&D Tax Relief Claims
The definition is relatively straightforward under the SME scheme: if there's a contract between two parties for R&D activities to be carried out by one for the other, these are considered subcontracted activities.
However, there are exceptions, including:
Paying another company for workers or materials for R&D
Any R&D activities that take place after a contract has ended, even if they are relevant
Providing expert advice and charging for time
When a company carries out R&D and receives a subsidy from another entity (this is considered subsidised expenditure)
When two companies jointly pursue R&D (each can potentially claim R&D Tax Relief for their share of the qualifying expenditure, known as collaborative research)
These activities do not qualify as subcontracting when claiming R&D Tax Credits.
Industries Commonly Involved in Subcontracting R&D Work
Subcontracting R&D work is not limited to a specific industry; it spans across various sectors. Common industries that frequently engage in subcontracted R&D work include:
Aerospace and Defense: Research and development in this industry often require specialized skills and resources, leading to subcontracted work
By engaging in subcontracted R&D work, businesses in these industries can access specialized expertise and resources, drive innovation, and potentially benefit from R&D Tax Relief.
Can SMEs Claim for Subcontracted R&D?
SMEs can receive up to 65% of the costs paid to a subcontractor for R&D work, as long as the subcontractor is not connected to the business. This also applies if the subcontractor employs a third party to complete the work, indicating that they don't have to perform the work themselves. If the companies are connected, meaning they are controlled by the same shareholders, the claim will be based on the lesser of the payment made to the subcontractor or the relevant expenditure of the subcontractor, provided that the total subcontracted work payment is considered when determining the subcontractor's profit.
Does Subcontracted R&D Activity Have to Take Place in the UK?
For SME scheme claims, there is no requirement for the subcontractor to reside in the UK, nor does the subcontracted R&D need to take place within the country (at least for the time being). However, the rules are set to change from April 2024, after which claiming for subcontracted work conducted overseas will no longer be permitted unless it is unreasonable for the company to replicate the conditions in the UK.
Does Subcontracted Activity Have to Involve Research and Development?
Under the SME scheme, the specific task performed by the subcontractor may not need to be classified as R&D on its own. For instance, a material might be sent for analysis or stress testing, or a manufacturing specialist might be needed to build a custom device. Although these activities might be routine for the subcontractor, they can still count as R&D because they are part of a larger R&D project.
Can Large Organisations Claim for Subcontracted R&D?
Larger companies claiming under RDEC generally cannot claim for most subcontracted work. However, there are exceptions: 100% of eligible spending can be claimed as long as the subcontractors are individuals, a partnership with individual members, or a qualifying body. A qualifying body could refer to a charity, a scientific research organisation, a health service body, or an institution of higher education, such as a university.
Can Subcontracted Companies Claim for R&D Tax Relief?
Subcontracted SMEs can claim for their R&D work through the RDEC scheme, preventing them from claiming under the SME scheme.
How Can RDI Help?
Navigating the challenges of subcontracted work and R&D Tax Relief can be complex. Our experts here at RDI can assist in maximising your potential benefits and ensuring compliance by reviewing your subcontracted work and identifying activities that qualify for your R&D Tax Credits claim. To take advantage of these benefits, speak to an expert today.