R&D claims: do you know your subcontractor from your externally provided worker?

Are you claiming the maximum and accurate research and development (R&D) tax relief for people costs, including staff and third parties? This question is likely to cause hesitation for many finance professionals, particularly as the UK guidance for R&D tax relief is complex and extensive.

There are three main types of people costs that you can include in an R&D tax relief claim:

• Staff – the staffing costs of directors or employees directly and actively engaged in relevant R&D for a given accounting period.
• Subcontractors – where R&D claimants engage with external workers to directly undertake a task on behalf of the company.
• Externally provided workers (EPWs) – where R&D claimants contract a staff provider to supply external workers, and effectively work as an extension of the company workforce.

HMRC is introducing new measures to tighten up on abuse of the UK R&D tax regime. This includes significant cuts to the net benefit that an SME will receive for qualifying R&D expenditure incurred from 1 April 2023. Additionally, HMRC’s R&D compliance team has expanded significantly over the past few years, meaning more companies will receive notice of an enquiry being made.

HMRC has recently shared an enquiry-related finding with financial professionals whereby claimants of research and development expenditure credit (RDEC) have included third-party costs as EPWs when they should have been categorised as subcontractors.

Why is this finding significant for HMRC in seeking to tackle abuse of the UK R&D tax regime?

There are two schemes in which you can make an R&D claim to HMRC: the SME scheme and the RDEC scheme, the latter of which is primarily designed for businesses that meet the criteria for a ‘large company’. The main difference between the two schemes is that, unlike SME claimants, RDEC claimants cannot include subcontractor costs within the qualifying R&D expenditure. In contrast, it is possible for both schemes to utilise EPW costs as an eligible category of qualifying R&D expenditure.

If an HMRC enquiry concludes that an RDEC claimant has wrongly categorised EPW costs, that business could be liable for a penalty for an inaccurate return. This is usually a percentage of the additional corporation tax due, which depends on whether HMRC deems the error to be careless, deliberate or concealed. Additionally, if an RDEC claimant has already been paid out by HMRC before the inaccuracy finding, the business will be required to hand back the calculated difference in net benefit. It is therefore essential that you correctly categorise people costs for each R&D scheme to maximise the chance of enquiries progressing as smoothly and seamlessly as possible.

The table below outlines the key differences among the different types of people costs, which include staff, subcontractors and EPWs.

Note: for the remuneration column, the ‘typical’ (i.e. common observation) method has been described and does not necessarily apply in all cases.

You should consider what you can do to minimise the risk of HMRC opening an enquiry into your R&D claim, whether under the SME or RDEC scheme. Within your R&D report, include a detailed breakdown of the different types of people costs that you have included within the qualifying R&D expenditure calculation. Using the table above as a starting point, show HMRC that you fully understand the difference between a subcontractor and an EPW.

Based on current draft guidance, the requirement to provide details of qualifying R&D expenditure within an ‘additional information form’ will become mandatory for accounting periods starting on or after 1 April 2023 when the Finance Bill is updated. So get into the habit of doing this sooner rather than later.

The R&D team at Moore Kingston Smith provides a high-quality tailored service based on your requirements, such as reviewing and correcting your R&D claim, calculating your qualifying R&D expenditure, preparing an R&D report that addresses HMRC’s criteria and filing your R&D claim to HMRC via the self-assessment corporation tax return.

If you would like advice on R&D-related issues, please do not hesitate to contact Sophie Iles on siles@mks.co.uk.