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Research and development (R&D) tax credits have been supporting innovative companies for nearly 20 years. Around £27 billion in tax relief has been awarded, stimulating investment in scientific and technological advancements across many industries.

But understanding how and when to make a claim can be complicated. You’ll need details of the activities conducted, the uncertainty they were intended to overcome and corresponding financial calculations.

When more than one company is involved, the process becomes even more complex. Which party is eligible for the relief? What is the difference between subcontractors and partners? 

The key to understanding your own position is to seek expert advice from a qualified professional, but here we’ll explore some of the possibilities in the context of HMRC’s guidance.

SME or large company?

When one company, operating alone, invests in R&D, establishing eligibility for tax relief is relatively straightforward. However, the realities of modern business mean multiple companies are often involved, taking responsibility for different aspects of a project.

There are two distinct schemes for R&D tax relief, so one of the first steps is understanding how your company is classified under HMRC’s definitions.

Small and medium-sized enterprises (SMEs) can claim under the SME scheme if they meet criteria that includes:

  • Staff headcount of less than 500, and;
  • Turnover of less than €100 million, or;
  • A balance sheet total under €86 million.

The tax credit for SMEs is worth 230% of qualifying costs, while loss-making firms can surrender R&D losses for a 14.5% payable credit. All other companies can make claims under the Research and Development Expenditure Credit (RDEC), which offsets 12% of the qualifying costs against tax liability.

Clearly, the SME scheme is the more lucrative option for those who are eligible, but the distinction between the schemes becomes even more important when multiple parties are involved.

Subcontracted R&D

One of the most common areas of confusion concerns subcontracted R&D work. HMRC’s calculations are clear, with SMEs permitted to claim against 65% of the cost of payments to external parties. If the companies are connected, the rules are more complex, but that is a topic for another time.

For larger companies, it is usually not possible to claim for subcontracted R&D expenditure unless the work is undertaken by a charity, higher education institute, scientific research organisation or health service body.

But the guidance does not help answer the question of who is truly responsible for the R&D. For that, you need to establish a clear understanding of the role of each party, ideally through a contract that spells out specific responsibilities.

If there is no clear and simple arrangement with well-defined contractors and subcontractors, it helps to look at some key criteria to determine who has the ultimate responsibility and is therefore eligible to make a claim.

Defining responsibility

Often the most important factor is financial responsibility. R&D tax credits reward innovation that comes through financial risk, so the company that incurs this risk is usually the one to benefit from a claim.

Consider the case of a software development project. A company may be tasked with providing a solution with no detailed specification, only a requirement for the end product, for a fixed fee.

If the company then embarks on an R&D project to develop an innovative solution, they are making the investment and assuming the risk of failure. The R&D is their own and they can claim for it, while the client is paying for a product.

If, however, the client engaged the company specifically to perform R&D and provides investment and direction for the project with no fixed fee, the client is assuming the risk. The client can then submit a claim if they meet the SME definition, although – as noted above – a larger company is unable to claim for subcontracted R&D. In this scenario, the subcontractor can then make a claim if they are an SME.

The key difference in an arrangement like this may be between performing R&D in the course of supplying a product or service, and performing R&D at the direction of a client with a financial investment.

Collaborative projects

Where there are multiple subcontractors involved, the work carried out by each individual firm may not necessarily be innovative but bringing everything together in new ways can be.

Such cases can arise on construction projects, where a combination of previously unrelated solutions can help overcome uncertainty. The lead contractor has taken responsibility and assumed the risk of failure, so they are likely to be able to submit a claim for their investment.

When projects are more collaborative, without a clear contractor and subcontractor, all organisations are permitted to claim relief on the qualifying costs they have incurred.

Ultimately, R&D projects rarely take place without significant planning, as the work is only eligible if it is intended to overcome specific uncertainty – spontaneous innovation does not quality under the R&D tax credits scheme.

However, in practice, applications are often considered after work has taken place and the lines of responsibility are no longer clear, or were never well-defined. Seeking expert advice on who should claim and how that claim should be submitted is essential to maximising the potential rewards on offer.