Four main categories
Let’s say you’ve identified a project (perhaps the only project your company is undertaking) and you’re trying to figure out what costs to include in the project. How do you do that?
The first thing to note is that HMRC defines only 4 categories of qualifying costs:
- Direct labour: that is, employees paid directly by the company (e.g. on the payroll, in the UK or elsewhere) to work on the project.
- External staff: staff hired from an external staff provider, but otherwise similar to employees – i.e. directly employed on the project.
- Subcontracted R&D: parts of the project that have been extracted and parcelled out to a subcontractor, typically with a specification for what needs to be delivered and a subcontractor agreement or contract.
- R&D Consumables: things that were consumed in the R&D.
The first 3 sections are relatively straightforward, though it’s worth noting that external staff that’s provided by a connected party can count as direct labour. A connected party is another company that is “connected” to the claiming company. (link to connected and partner enterprise)
Of course, this wouldn’t be fun without exceptions!
Even though HMRC will happily declare, that these are the only 4 categories of costs that qualify, and use that to reject various costs that you want to include, their own web page states otherwise.
Additional costs that are explicitly states as qualifying are:
- payments to clinical trial volunteers (of relatively little relevance to startups)
- software licences
- utilities (power, fuel – but not data or telecommunications costs!)
In practice there are some other costs that will qualify as well, even though they are not listed here, and may be rejected by some R&D units.
As for why heating and lighting qualify for R&D relief, but data costs do not, I leave that up to the reader to divine.
Let’s talk numbers:
The process for adding the costs up for employees is very straightforward:
- For each employee, calculate the “total emolument” for the employee – that’s the cost of their gross salary, Employer’s NIC, pension, and bonuses that are R&D related.
- Multiply that number by the percentage of R&D involvement the employee had.
- Add up all the resulting numbers: this is the qualifying R&D expenditure for employees.
As mentioned earlier, subcontracted projects either count as a whole or not at all, and are apportioned at 65%. The process is fairly similar, except that there are no arbitrary percentages, and the table ends up looking fairly similar:
Externally Provided Workers
EPWs are halfway between subcontractors and permanent staff. Unless they were hired purely to perform R&D, they will often have a percentage apportionment for their time. This percentage further needs to be multiplied by 65% to arrive at the final apportionment. Again, if the EPW charges VAT, that should not be counted as part of their cost.
Remember that costs do not include VAT.
Note that if a subcontractor did more than one project for the claiming company, only the projects that were part of an R&D project should be included here.
R&D Consumables and Software Licences
There are various ways to calculate these, but we find that they generally fall into two categories: apportioned expenses, and wholly R&D expenses.
Things like “Light and Heat” are typically apportioned based on the R&D percentage of the company’s total activity. This R&D percentage is basically calculated by adding up the percentages of all the people using the service/consumable, and dividing it by the total number of people. So, for example, if you had 5 people in the office with R&D involvements of 10%, 30%, 30%, 40% and 80% respectively, you would apportion 10%+30%+30%+40%+80%/500% = 38% of the Light and Heat costs to R&D.
This method of calculation should be applied to things like Light and Heat, which are accepted by HMRC as acceptable R&D consumables, but which are shared between other people.
The other method applies to consumables and software licences that are wholly consumed by the R&D process. In those cases, the entire consumable cost is included, at a rate of 100%.
For more steer on what qualifying costs to include, get in touch to make sure you are not over (or under!) claiming. Good luck!