If you have ever submitted your own Research and Development Tax Credit claim – you’ll probably have had some head-scratching moments. Trying to figure out the difference between sub-contractors, externally provided workers, and what you can and can’t claim for can be difficult. Well you need worry no longer. This article is designed to explain all things related to ‘third-parties’ when it comes to making R&D Tax Credit Claims for SME’s.
First – what do I mean when I refer to ‘third parties’. In the context of this article, I’m referring to any entity that you work with on your R&D that is separate to your company. That could include a contractor or agency worker, another company, or a partnership. This does not include any of your employees.
If any of the above apply to you – read on. Alternatively, all your R&D is performed by your own employees – go make yourself a cuppa - you don’t have to worry too much about the explanations below.
For third party costs related to R&D – you can’t claim the full cost as part of your R&D claim – even if the third party spent 100% of their time and resources on R&D. Normally you can only claim 65% of the costs – but this isn’t always the case.
You also need to consider when a third party performs R&D on your behalf – who should make the R&D Tax Credit claim. Are you really performing the R&D – or is it the third party? And there are different rules if you are connected to the third party in some way.
Let’s start with Externally Provided Workers or EPWs. To be considered an EPW – the worker must be an individual, who is contracted or employed through an agency. The EPW also needs to be under the instruction of the company who is performing the R&D.
It’s worth noting here – EPWs can’t be self-employed. That means if there isn’t an employment agency – the worker doesn’t qualify as an EPW. However, if you use self-employed contractors for your R&D; the costs may be eligible as ‘sub-contractors’ – so read on to find out.
If you employ EPWs for your R&D project – you can claim a proportion of the cost as part of your R&D claim. Tax credit relief is given at a rate of 65% of the eligible payments made to any EPW. And like other staff, you can only claim for the percentage of the time the worker spent on R&D.
As an example – if you employed Elaine through an agency for a month and paid £2000 to the agency, but Elaine only spent half of her time on an R&D project. This means you can claim £650 as eligible expenditure. That’s 50% of the total cost, giving us the costs which related to R&D (£1000), then scaled down to 65% as Elaine is an EPW (£650).
But what if your third party wasn’t employed through an agency? They are likely to be considered a sub-contractor.
Where you’ve contracted a third party to perform a part of an R&D project on your behalf – they are referred to as ‘sub-contractors’. The key bit here – is they must be contracted to perform part of the R&D project, not just generally to provision labour or materials. If that conditions is met, and the project your claiming for qualifies as R&D – any element of work that is sub-contracted within that project should qualify for R&D tax relief – even if it isn’t specifically R&D work.
There are some other things that need to be considered so you can include the correct proportion of sub-contractor costs in your claim. First – should you or the sub-contractor be claiming the R&D tax credits, and second – if you are ‘connected’ to the sub-contractor.
It probably doesn’t surprise you that HMRC don’t want more than one company claiming for the same R&D. So, before you make any claim – you need to make sure that any company you sub-contracted the work to isn’t also claiming. If you’ve agreed between yourself and the sub-contractor who will include the cost of their work within an R&D Tax Credit claim, there’s no issue here. But otherwise – here are some things to consider when assessing which company should make a claim:
Using these parameters – it should be possible to determine which company should be consider as being responsible for the R&D, and which was a sub-contracted party.
What if the company you’ve sub-contracted to is connected to your company? A company is considered as connected if the same shareholders or people connected to the same shareholders have control over the company.
If this is the case, and the connected company is UK based, you’ll only be able to claim the lower of
You can calculate the expenditure of the sub-contractor in a similar way to calculating your own R&D costs. However, it’s worth noting that any third-party costs which were incurred by a connected sub-contractor aren’t eligible to be included. This is because HMRC deems that any third parties required for the R&D should have been engaged through the company which is responsible for the R&D, not the sub-contractor.
So now you know who your sub-contractors are, and how much of their costs are eligible. What next? Well - just like EPWs, the costs need to be apportioned according to how much of their work was on the R&D project, and then relief is given at 65% of the subcontracted R&D costs. Let’s run through some examples:
You’ve contracted Jones Consulting Ltd to perform part of your R&D project. You’ve paid them £10,000. However only 75% of the work they did was related to the R&D project. This means you can claim £4,875 as eligible expenditure. That’s 75% of the costs which related to R&D (£7,500), scaled down to 65% as Jones LTD is a sub-contractor (£4,875).
You’ve contracted Sister Company LTD as a sub-contractor – but you are the only shareholder of Sister Company LTD and the company performing the R&D. Because of this, the companies are connected companies – so you can claim the lesser of the payment made to the sub-contractor, or the expenditure of the sub-contractor as eligible costs. You paid Sister Company LTD £6000 for the work, but the costs incurred by Sister Company LTD was only £5000. As such you can claim 65% of the lesser of the costs – that’s 65% of £5000 which gives you £3,250 of eligible expenditure.
Allowing for third party costs in your R&D Tax Credit claim can be complicated – but hopefully this article has made it a lot clearer.
If you’re still unsure, or if you ever need specialist advice on any element of making a claim, we can help. Contact us at any time for a no-obligations discussion with one of our team.
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