However, as corporation tax agents for our clients, we are sometimes asked to file other firms’ R&D claims and have a duty to review them under our professional bodies’ rules on professional conduct in relation to tax (PCRT). In this blog, we look at five of the most common mistakes companies make when preparing an R&D tax credit claim:
1. Not claiming under the correct scheme
This is by far the most common mistake and can lead to very significant sums of money having to be repaid back to HMRC!
R&D tax relief is subdivided into two very different schemes, depending on a large number of factors.
There is the SME scheme for small and medium sized companies with tax relief available of up to 33.35%, and the R&D Expenditure Credit (RDEC) for large companies with tax relief of 10.53%.
Most advisers know that HMRC’s definition of an SME is to have fewer than 500 employees and either a yearly turnover of less than €100 million OR a balance sheet total of under €86 million.
However, there are a number of further tests to determine whether an R&D claim or project should be made under the SME or RDEC scheme which are often over-looked, including where the company:
- is a member of a 51% group
- has any linked and/or partner enterprises under the EC definitions
- has any private equity shareholders and it becomes a venture capital company
- is in receipt of grant funding, which is notified state aid
- is incurring the qualifying expenditure in carrying on R&D activities as a subcontractor
- has R&D expenditure which has been met, directly or indirectly, by another person (including potentially customers) and so is “subsidised expenditure”.
There is currently some disagreement between the tax profession and HMRC on what constitutes “subsidised expenditure”, meaning this needs to be reviewed on a case-by-case basis.
The SME status is lost if any one of the above points applies, and so care needs to be taken to ensure the correct scheme is being claimed.
2. Claiming consumables that are not qualifying expenditure
Everyone wants to maximise the qualifying R&D expenditure in their claims and including the costs of consumable items that are, for example, components of a prototype that is used in testing and then scrapped has always been intended to qualify.
Likewise, an apportionment of water, fuel and power to the R&D activities will be accepted by HMRC.
However, where a company sells or otherwise transfers ownership of items produced in the course of its R&D activity as part of its ordinary business, then the cost of consumable items that form part of those products is excluded from expenditure qualifying for relief.
Using the example above, if the prototype was sold to a customer, even at a discount or gifted to someone else as a goodwill gesture, the costs of the parts cannot be claimed as qualifying R&D expenditure. This is the point that is often missed by other firms and their claims could successfully be challenged by HMRC.
3. Not giving HMRC details of your competent professionals
Most firms include some technical narrative on the qualifying R&D projects that the company is claiming as qualifying for R&D tax credits.
However, I see many other firms’ R&D tax credit claims where they do not give any details of the people leading the R&D projects and their professional qualifications and industry experience.
In many cases, the competent professional will have BSc/MSc/PhDs in their relevant areas of expertise. This, together with their number of years of industry experience and previous blue-chip companies where they may have worked, can be very persuasive to HMRC that they are competent professionals, directly undertaking qualifying R&D.
The competent professional section is therefore a valuable section to our UHY R&D claims.
4. Not claiming staffing costs for qualifying indirect activities (or claiming too much)
HMRC make it really clear in their R&D tax relief manuals that qualifying indirect activities (QIAs) can be included in the qualifying R&D tax expenditure, and the DTI guidelines themselves give seven examples of activities that form part of a project but do not directly contribute to the resolution of a scientific or technological uncertainty.
In terms of errors and mistakes, they are two-fold with QIAs. I see many R&D claims with no QIAs whatsoever in companies that have plenty of indirect supporting people such as IT, finance, HR and technical sales staff.
However, only activities undertaken to support the R&D team, or the R&D project, should be claimed as QIAs and, in my experience, this is up to approximately 5-10% of their total annual time as a maximum. I have seen some other firms claiming 20-25% of staff’s time as QIAs which I believe would be difficult to justify to HMRC, based on their rules, in most circumstances.
5. Capitalised R&D expenditure
Some companies decide to capitalise their in-house R&D or software development costs as Intangible Fixed Assets (IFAs) in their accounts if they believe there is an enduring benefit to the trade.
R&D tax credits are only available on revenue expenditure that is deductible for tax purposes, whereas capital expenditure will only generally obtain 100% R&D allowances.
However, it is possible to elect to treat expenditure that is capitalised as an IFA as revenue expenditure for tax purposes, so long as the expenditure:
- is recognised either as a deduction in computing the profit or as an intangible asset in accounts beginning on or after 1 January 2005, and
- is not prevented from being an allowable deduction in calculation of profit for that period (for example because it is pre trading expenditure for a company within the large company scheme, or because it is capital expenditure for tax purposes), and
- the expenditure is incurred during the accounting period.
Irrespective of the R&D tax relief, this allows 100% of the expenditure to be deducted in computing the taxable profit when it is incurred irrespective of whether it appears as a deduction in the profit and loss account. As you would expect, the future amortisation is then disallowable for tax purposes, but the cash-flow benefit and tax saving are immediate.
Once the capitalised R&D expenditure is elected to be revenue for tax purposes, the usual qualifying R&D expenditure categories can then be claimed for tax credit, giving a two-fold tax saving. Many R&D tax credit boutiques are not aware of this corporation taxes act election, and it is commonly missed.
The next step
For more information about the impact of common R&D tax credit errors on your own business, or to discuss your potential for an R&D tax claim, please contact Kevin Edwards, or your usual UHY adviser.
