This comprehensive guide explains which costs are eligible for R&D Tax Relief and how much of each one you can claim.
Qualifying companies can claim for a range of costs under R&D Tax Relief, including wages, subcontractor fees and raw materials.
If you want to secure your full funding entitlement, you need to make sure you identify all of your eligible costs, apportion them correctly, and include them in your claim.
To stay compliant, you need to make sure you’re not claiming for anything that isn’t eligible or that isn’t attached to a qualifying activity. In line with new requirements introduced on 8 August 2023, you also need to break out your costs by type and list how much you spent on indirect activities.
To help you do this, my colleagues and I have compiled this detailed breakdown of eligible costs, including how much of each one you are allowed claim for.
If you have any questions about your costs, just get in touch. Our experts would be happy to help!
The ten kinds of qualifying R&D costs
There are ten types of development-related costs that qualify for relief. They are:
More on each of these categories below.
At the bottom of this guide, we also explain which costs HMRC specifically lists as being ineligible for funding.
1. Direct staff costs
This is the cost of paying employees that worked directly on the R&D project. Costs that qualify are:
- Class 1 National Insurance Contributions
- Pension fund contributions
- Reimbursed R&D-related travel costs
You can calculate how much to claim for by:
- Calculating the total annual emolument (i.e. the sum total of the costs listed above) of an employee that worked on the R&D project
- Multiplying this amount by the proportion of their time they spent on the R&D project in the year
- Doing this for all employees that worked on the project, and add the figures together
|% Time Spent on R&D
Total claimable direct staff costs: £45,620.80
2. Externally provided worker costs
Externally provided workers or ‘EPWs’ are temporary workers sourced from an external agency. They work like regular employees, but their contract is with the agency, not with you.
Tax relief is given on 65% of the payments to the external agency, regardless of the size of your company.
Like regular staff, EPW cost must be apportioned based on how much time the worker spends on qualifying R&D.
If the EPW charges VAT, you shouldn’t count that as part of the cost.
|% Time Spent on R&D
|Incl. 65% Ceiling
Total claimable EPW costs: £8,463
3. Subcontracted R&D costs
Generally speaking, subcontracted R&D means you’ve outsourced a piece of your R&D project to another company for an agreed free. If, for example, you hired an external firm to develop a software module on your behalf, that would count as subcontracted R&D.
Under the scheme’s guidelines, if a project qualifies for R&D Tax Credits then sub-projects related to it also qualify for tax relief, even if they involve ‘routine’ work.
Routine work means work that doesn’t satisfy the government’s definition of R&D for tax purposes.
So, if a contractor is taking on a sub-project involving routine work, but that sub-project is part of a larger qualifying project, then the subcontractor’s costs would qualify for tax relief.
Like staff costs, subcontractor’s fees must also be apportioned based on how much of that fee went towards the R&D project you’re claiming for. Like EPWs, companies can claim up to 65% of their subcontracted R&D costs.
Only companies eligible for SME R&D Tax Relief can claim relief on the cost of work subcontracted to a limited company.
However, companies applying to the RDEC scheme can claim relief on subcontracted work undertaken by “a charity, higher education institute, scientific research organisation or health service body — or by an individual or a partnership of individuals.”
|% Fee for R&D Project
|Fee incl. 65% Ceiling
Total claimable subcontractor costs: £90,545
4. Costs for R&D consumables
Spending on consumables, which are resources that are used or ‘used up’ in the R&D process, are eligible for relief.
Included in this category are materials and utilities like water and heat.
Consumable costs generally fall into one of two groups: apportioned expenses and wholly R&D expenses.
Utilities are usually apportioned expenses, meaning how much you claim for is based on how much of the cost can be attributed to qualifying R&D projects.
For utilities, you can use the following method:
- Count up how many employees worked on the R&D project
- Find out the amount of time each of those employees spent on the project, as a percentage of total time at work
- Add up those percentages
- Divide that by the total number of people in the company
Let’s say your company consists of five employees. If two of these employees spend 50% of their time on R&D, while the others do not contribute to R&D at all, you calculate the R&D percentage as follows:
First, add up the R&D contribution of each employee. In this case, it’s 50% (from the first R&D employee) + 50% (from the second R&D employee) = 100%.
Next, divide this total percentage by the total number of employees. In this case, 100% divided by five employees equals 20%.
Therefore, you can claim 20% of your eligible utility costs as R&D expenses.
5. Software costs
You can claim for the cost of software needed for R&D. If the software was bought purely to be used in R&D, then you can claim 100% of its price in your application.
If the software package is only partly employed in R&D, it’s price must be apportioned, based on how much of its use is R&D-related.
6. Clinical trial volunteer costs
Payments made to volunteers participating in qualifying clinical trials are eligible for R&D Tax Relief.
This cost is usually only relevant to pharmaceutical firms.
7. Contributions to independent research
These are payments made to other organisations carrying out eligible R&D.
Only companies claiming under the RDEC scheme can claim for these costs, which qualify for relief with two stipulations:
1. The recipient must be conducting research relevant to your field or industry.
2. The recipient must also be “a qualifying body” – a charity or higher education institute, scientific research body or health service organisation – or “an individual or partnership or individuals”.
8. Prototype costs
Costs associated with the design and construction of a prototype needed to test the R&D you’re undertaking are eligible for relief
100% prototype costs qualify unless you’re planning to sell the prototype. If so, HMRC is likely to classify it as a ‘first of class’ item.
In most cases, the build costs for first of class items do not qualify for relief. However, building a first of class product can entail a significant level of work to overcome scientific and technological uncertainties.
Costs associated with this work – wages, subcontractor fees, etc – may qualify for relief.
9. Cloud costs
From 1 April 2023, certain costs related to purchasing cloud computing solutions will be eligible for R&D Tax Relief.
These costs must be associated with activities that directly contribute to resolving a scientific or technological uncertainty.
If you use a cloud computing service, such as AWS, for both qualifying and non-qualifying work, HMRC allows you to allocate a ‘reasonable’ percentage of the costs to your claim.
This change is part of a wider range of reforms that have taken effect in 2023.
10. Data license costs
Some costs associated with data licenses incurred after 1 April 2023 have also become eligible relief.
Costs associated with creating a dataset – wages for employees that were involved, for instance – will be eligible for relief. Data licensing fees will also be eligible for relief unless you are contractually allowed to publish the data or sell to or share it with a third party.
Like the inclusion of cloud-related costs, the eligibility of data license costs is designed to ensure that the R&D Tax Relief scheme aligns with the current landscape of research and development.
There are four types of costs that are not eligible for R&D Tax relief. They are:
- The production and distribution of goods and services
- Capital expenditure
- The cost of land and hosting
- The use of or creation of a trademark
Because it’s HMRC, there are exceptions to each of the categories.
If you’re unsure whether you should include an expense in your application, the best thing to do is speak to an expert like GrantTree.
Claim your full entitlement with GrantTree
Hopefully, this guide has shed some light on which costs qualify for R&D Tax Relief.
As mentioned, all companies now need to break out the costs they’re claiming for – in the new additional information form.
This change puts companies under considerable scrutiny and increased pressure to make sure every penny of expenditure in their claim is valid and defensible.
If you want to make sure your company is claiming your full entitlement to eligible expenditure, our experts are standing by to help.