8 R&D rules - Subcontractors & Contractors
Updated: Oct 17
When it comes to R&D Tax Relief, subcontractors need to be considered carefully. On too many occasions now, we have seen companies miss out on money that should have been back in their business, and you don’t want that to be your clients.
In this article, we look at eight rules to determine WHEN subcontractors, and contractors can claim, and WHICH scheme they can claim via.
KEY TERMS & DEFINITIONS
Let’s start with some key terms and definitions, as it might get a little technical in here….
The Contractor is the company that has ownership of the R&D project, and hires the Subcontractor.
The Subcontractor is the person or company hired to deliver work that contributes to the R&D project.
There are two different Subcontractor types:
A Connected Subcontractor is a company or individual controlled (meaning owned more than 50%) by the same shareholder(s) as the contractor.
An Unconnected Subcontractor is any subcontractor that is not a connected subcontractor.
Finally, here is a very quick description of the two R&D schemes available to claim via:
The RDEC scheme allows a company to claim up to 13% cash back of qualifying costs incurred.
The SME scheme allows a company to claim up to 33% of cash back of qualifying costs incurred.
SUBCONTRACTORS: WHEN TO CLAIM & WHICH SCHEME TO USE
As a subcontractor there are two main scenarios with specific rules around when and what R&D can be claimed.
SCENARIO 1 – When a business is acting as a subcontractor to a large company, the subcontractor can claim but only via the “RDEC” scheme.
Example. A small company who specialises in testing products to satisfy a certain legal regulation. If a large multinational company was making a new product and contracted the small company to do some tests, the small company can potentially claim under RDEC. Note that in this case the large company cannot claim for the costs paid to the small company, so there is no risk of a ‘double claim’ occurring.
SCENARIO 2 – When a business is acting as a subcontractor to anyone, but they are doing their own separate R&D project alongside that work, they can claim via the SME scheme.
Example. The small company above is improving an internal process for the testing of products that will lead to efficiencies in the delivery of its services to all customers. Staff within the team spend time specifically trying to develop the process. This could count as a separate project, claimable under the SME scheme.
SUBCONTACTORS CAN’T CLAIM WHEN…… a business is acting as an SME subcontractor to another SME for their R&D project, they cannot make an R&D claim.
Example. The testing company above is doing work as a subcontractor to another SME. The SME contractor may be able to claim (under the SME scheme) for the payments to the testing company, and so to avoid a ‘double claim’, the testing company cannot make a claim itself for work on this project.
CONTRACTORS: WHEN TO CLAIM & WHICH SCHEME TO USE
As a contractor there are four main scenarios with specific rules around when and what R&D can be claimed, for payments to subcontractors:
SCENARIO 1: When a large company subcontracts to individuals, partnerships or qualifying bodies (excluding limited companies), it can claim via the RDEC scheme.
Example. A large multinational contracts some research from a university on its project.
SCENARIO 2: When an SME company is grant funded / subsidised and subcontracts to individuals, partnerships, qualifying bodies (excluding limited companies), it can claim via the RDEC scheme.
Example. A small company wins a grant to develop proprietary software for an online portal that will have significant economic and environmental impact if adopted by the target market. Some of the software development is contracted to a freelancer who is an individual. These subcontracted costs could be claimable under the RDEC scheme.
SCENARIO 3: When an SME company subcontracts a specific part of an R&D project to an unconnected party, it can claim for 65% of the costs as qualifying expenditure via the SME scheme.
Example. The same company as above is developing a similar piece of software to test commercial application in a different industry. A third party company is used for the some of the development work costing £30,000. A claim may be available for this cost, under the SME scheme, for up to £6.5k as a cash credit.
SCENARIO 4: When subcontracting R&D work to a connected subcontractor, a business can usually claim via the SME or RDEC scheme, however the rules for what they can claim for may be more or less restricted based on the circumstances.
CONTACTORS CAN’T CLAIM WHEN…… subcontracting to Limited companies under the RDEC Scheme, a business cannot make an R&D claim for those costs.
Example. The company above, who won a grant to develop proprietary software, outsourced some of the software development to individual freelancers, and some to a limited company agency. Only the costs paid to the individuals is within scope to claim. The amounts paid to the limited company cannot be claimed.
HMRC PAYE CAP
Please note from 1 April 2021, HMRC brought in a limit on the payable tax credit a business can receive from a claim via the SME R&D Tax Credit Scheme. This means businesses can only claim tax credits up to the value of 300% of their combined PAYE and NIC liability (the first £20,000 is exempt). Any amount over this limit will be lost.
The cap specifically applies to businesses that are unprofitable, and businesses that end up with an ‘artificial loss’, which they could then surrender for a cash injection, because of the enhancement mechanism of the R&D Scheme. In these circumstances, subcontractor fees from businesses that are unconnected may be restricted from being eligible for R&D tax credits, as might salaries for overseas workers. However, businesses should still be allowed to include a fraction of the PAYE & NIC liability of a connected business that is delivering R&D activities for them.
There is however an exemption to be aware of, for which a business needs to pass a two test criteria. For the first test a business’s employees must be “creating, preparing to create, or actively managing intellectual property” AKA Patent Box.
The second test is based on a calculation of fees paid to subcontractors and externally provided workers of connected businesses. This total amount must be no more than 15% of a company’s R&D expenditure.
If the company passes both tests, they will be exempt from the cap.
Finally, quick tip, it’s also worth noting that contractors do not have to be based in the UK, and the R&D work they deliver, does not to have to be undertaken in the UK. Your clients will thank you for that bit of knowledge!
The rules are complex when it comes to subcontractors and R&D, but you don’t need to get bogged down in all of this. We work with our accountant partners either as their partner, or white-labelled to make sure their clients are fully informed and submitting accurate R&D claims, year after year.
Radish Tax, Your R&D Tax Relief Service
For DTX’ers with a potential R&D Tax Relief client you’d like to discuss please book a scoping call here.
Radish Tax by Diagnostax is a specialist R&D Tax Relief provider. Find out more about Radish Tax by Diagnostax.
Please note, as this blog was published prior to 1st April 2023, there is no reference to the changes which have been brought into place for the R&D tax relief schemes.
For expenditure on or after the 1st of April 2023, the following changes in rates of relief apply:
SME – the Enhanced Expenditure uplift rate has fallen from 130% to 86%; and the tax credit rate has fallen from 14.5% to 10% (exc. R&D intensive loss-making SMEs).
RDEC – the credit rate has increased from 13% to 20%.
Further, data and cloud computing costs can now be included within the claim qualifying expenditure calculation. Pure mathematics now falls within the scope of the relief.
For submissions on or after the 8th of August 2023, it is now required for an Additional Information Form to be submitted prior to submission of the R&D claim. For reference, please see our blog here.