Claimable Costs | What Costs Can You Include in your R&D Tax Credit Claim?

The size of any claim for R&D Tax Relief is determined by your claimable costs. So - what are claimable costs? In short - they are the costs your business incurred as a result of your R&D project which you are allowed to claim R&D Tax Relief on. You might also hear them referred to as ‘eligible costs.’ They matter because the more claimable R&D costs you have, the higher your R&D Tax Credit claim will be.

There are 5 different types of claimable costs. In this article, I’m going to explain what these types are, and everything you need to know about them. Once you know your claimable costs – you’ll be able to calculate your returns from your R&D claim. You can find out more about calculating your return in this article.

Staff Costs

Your first type of claimable cost is the cost of your employees. You can include the cost of any staff time spent on your R&D project in your claim. This includes their wage/salary cost, the cost of employers' national insurance and pension contributions, and any relevant expenses which were paid by the employee and refunded to them.

If you don’t have a time-keeping system, you may not know exactly how much of your employee’s time costs are claimable. If this is the case, you’ll need to determine, as accurately as reasonably possible, the proportion of an employee’s time spent on R&D.

For example, if Joe Bloggs spent 60% of his time on R&D throughout the year, you could include 60% of his salary, employers NI and employers pension costs for the year in your R&D claim.

However, you can’t include all staff costs. Here are the main exceptions.

Staff Costs Which Aren’t Claimable

• The cost of time that your staff spend that isn't helping to create a technical advance. For example, time spent by employees outside of the R&D project, or on admin tasks such as bookkeeping or payroll.
• Dividends paid to directors are not claimable costs, however you can include directors’ salaries, pensions, and employers NI contributions.
• The cost of agency workers and sub-contractors is treated differently. Read on for the explanation under third party costs.

Top tip: increasing the pension contribution of directors who are involved in R&D can provide substantial increases to your R&D Tax Credit returns whilst providing a tax-efficient form of remuneration.

Third Party Costs

What if part of your R&D is performed by agency workers – known by HMRC as Externally Provided Workers (EPW). Or alternatively – you’ve sub-contracted out part of your R&D to another party.

Where employing a third party to work on your R&D projects (such as EPW’s or sub-contractors), the costs are claimable. However, to reflect the mark-up associated with using EPWs, or sub-contractors, you can't claim the full value of the cost. You can only claim for 65% of the third party costs which relate to R&D.

The only exception to the 65% scale, is where the agency or sub-contractor is connected to your company. For example, if they share the same shareholders, or their shareholders are closely related. The definition of related/connected parties is detailed here. In this case – the claimable amount is the lesser of the costs incurred by the agency or sub-contractor, and the amount paid by yourselves. This rule is designed to stop people from artificially inflating third party costs to increase their R&D tax credit payout.

Let’s walk through these scenarios with some examples.

Standard Third-party Scale

You’ve employed a sub-contractor to work solely on R&D throughout the course of your project. Your company isn’t connected to the sub-contractor. The total cost of the work was £10,000. Because they are an un-connected sub-contractor you need to apply a 65% scale to this cost – meaning the claimable cost is £6,500.

Third-party Not Fully Engaged in R&D

You’ve employed an EPW (agency worker) throughout the course of your project, but they only spent 50% of their time on R&D. The total cost of the agency worker was £10,000 however this should be reduced to 50% to reflect that they weren’t working solely on R&D. Additionally, because they were employed through an agency – you need to apply a 65% scale. This means the claimable cost is £10,000 x 50% x 65% = £3,250.

Connected Third-party

You’ve employed a worker through your brothers’ employment agency to work solely on R&D. You’ve spent £10,000 on the agency worker, but the cost of the employee to your brothers’ employment agency was only £8,000. Because your brothers’ employment agency qualifies as a connected company, you can only claim the lesser of the amount you’ve spent and the cost to the connected company. In this instance – the claimable cost is £8,000.

Material Costs

You can include the cost of materials used up during your R&D project. Normally these will be materials you’ve used up in prototyping a new product, in performing any trials, or which were otherwise required to support the R&D.

The materials, or consumables as HMRC refer to them, cannot be claimed if they were incorporated into an item that went on to be sold. If only some of the materials were incorporated into an item that was sold – you can claim for the cost of those which were not.

You may not have a detailed record of material costs, or which materials were incorporated into products that were sold. If that is the case you should perform a reasoned estimate of the cost of materials, based on the costs you’ve incurred which are likely to relate to R&D and not to have been incorporated into products that were sold.

Utility Costs

Also considered by HMRC as 'consumables' - you can include the cost of utilities used up in your R&D project. This might include fuel, electricity, gas or water. You'll probably need to apportion the expenditure, and only include a reasonable amount that is attributable to the R&D.

Software Costs

Finally, you can claim any software costs that relate to your R&D project. For example, if you needed to purchase a design programme solely for your R&D project, the costs associated with it are claimable. This may include purchase costs as well as licensing costs.

However, if you use the programme for work that isn’t related to R&D, you can only include the relevant apportionment. You might calculate this by estimating the number of hours users spend on R&D work, in comparison to other work.

Summary

So, there it is – everything you need to know about what costs you can include in your R&D tax relief claim. However, at this stage, I should issue a word of caution. Although these rules may seem simple, it can be easy to miss claimable costs. For proof, see how we have doubled the claimable costs for our clients when we reviewed claims made by themselves or another advisor.

If you want to get the best results – we’d recommend getting professional advice. Get in touch if you want to discuss your claim.

Alternatively, now you know how much of your costs are claimable – you can read our next article to find out how much you’ll get back with your claim: R&D Tax Credit Calculation | How Much Will You Get Back and How are Your Returns Calculated?.