Over the last couple of years, we have said hello to several R&D tax relief changes whilst the tax industry has reported an increased number of HMRC compliance checks and enquiries.
To ensure compliance and support any potential HMRC enquiries received, companies and their advisers have been keen to understand how best to record the R&D project(s) undertaken and what information they need to retain on file.
As R&D claims can be submitted up to 2 years after the accounting period ends (so really up to 3 years) since the project(s) started, it can be challenging for busy business owners to remember what happened and when. Timely recording of information when the project is being carried out can speed up the preparation of the claim and improve claim accuracy.
You may be aware that there are two key areas of an R&D Tax Claim – the Qualifying Expenditure i.e. the Financials and the Technical Projects. Both have equal importance in qualifying and quantifying a claim.
HMRC introduced a new way to submit your R&D claim with the launch of the Additional Information Form from August 2023. This sets out exactly the information that HMRC needs to be able to process an R&D claim. However, HMRC don’t provide much information regarding how best to record the Qualifying Expenditure and the Technical Projects.
But don’t worry, we’ve got you covered 😏 This blog will breakdown the two key areas and provide recommendations on what information should be recorded.
Part 1: Qualifying Expenditure
When HMRC are asking for evidence for Qualifying Expenditure, these are the sort of things they are looking for:
1. Time Sheets or log of staff time - breakdown of time spent on R&D activities compared against contracted hours.
If you’ve got a timesheet system in place, the addition of different projects or activities within said projects can enable staff to record R&D time as they go along.
Or the implementation of completing a document at a regular period that notes the hours done on R&D projects and what activities were undertaken.
Even the utilisation of an outlook calendar could provide the information you need without overburdening those involved.
2. Payroll Reports
3. Specific reports or codes for qualifying costs from the company P&L:
o Direct consumables
o Subcontractor costs
o Externally Provided Workers
o Software Licences
o Data Licence
o Data Sets
o Cloud Computing
4. Ability to generate reports or codes for qualifying costs that are part of R&D but not directly:
o Heat & Light
o Software Licences
o General consumables
For costs, there will likely always be a way to get this information stored and exported within your accounting system. This can be via the use of new nominal codes in the Chart of Accounts or utilising tracking features, for example Xero has the ability to track costs with two additional categories and QuickBooks has a projects module.
5. The invoices for each of the costs included.
By knowing the types of things HMRC are looking for, companies undertaking qualifying R&D activities will be able to correctly document and evidence all the required information. So when it comes to submitting an R&D Tax Claim, you will have the peace of mind that you have covered all basis and can provide the information to HMRC upon request.
HMRC will want all costs to be split over every project and any that relate to Qualifying Indirect Activities. Now this is trickier to track given there are two areas to look at, the cost being R&D and then what does it relate to. There is scope for this to be done within your accounting software, but it may need to come out of the system if certain features are already being utilised.
The more specific you can be, the lower level of estimates based on knowledge of the business, is the ideal position to be in when making a qualifying claim.
Your chosen R&D tax adviser will request this information from you and analyse the detail with a view to calculating the R&D claim. They may request further evidence or ask you questions based on their analysis.
Part 2: Technical Projects
There are four areas that summarise the areas HMRC want information on and will help identify if the projects are qualifying or not.
Here are our recommendations on the information you should keep on file:
Baseline / Industry Knowledge
In this area HMRC want to know what the industry norm is/what a Competent Professional* can figure out easily/what is known in the public domain.
Tip: log what research was done and any comparisons that could be made between the work you are aiming towards and what is out there / known in the industry.
Areas to consider are:
What is readily available in the public domain?
Could this be readily deduced by a Competent Professional?
What would the industry normally do to solve this problem?
For each of those, you would need to note research and considerations as to why you cannot either find a solution/ develop a solution easily and why you are deviating from what the market knows.
Bonus tip: References to checks and screenshots will further bolster this as if the R&D claim is enquired into HMRC will no doubt do their own research online, but that will be as of the enquiry, rather than when the project started.
What is a Competent Professional?*
Competent Professional is defined by HMRC as someone who, in their respective field of expertise is:
Knowledgeable about the relevant scientific and technological principles involved,
Aware of the current state of knowledge, and
Have accumulated experience and be recognised as having a successful track record.
Simply having worked in a field or having an intelligent interest in it does not, by itself, make a person a competent professional.
There may be differences of opinion between competent professionals in a particular field. Where the view taken is a legitimate one, and it has been reached by a competent professional properly exercising his expert judgement then it should normally be accepted.
Competent Professionals are crucial to be able to identify, undertake and justify an R&D Tax Claim as well as sign off the R&D claim.
Advance Sought
In this area HMRC want to know what it is you are seeking to achieve. Typically, this can be honed in to four separate segments:
1 - The General Advance being sought
In this segment, provide a simplistic overview of what you are trying to achieve.
2 - The Specific Advance being sought
A detailed and precise advance must be noted. It is best practice for the Competent Professional* to consider how to phrase this and use appropriate technical terms. These terms should then be explained in an appendix or footer note.
3 – The Field of Science or Technology you are working in
Companies need to provide information regarding the field of science or technology they are advancing. If the field is well known or understood, then usually a short sentence is enough to provide context here. But keep in mind, if this is an area where not much is known, additional context will be needed. In most projects there should not be a long list of reasons the project is advancing the field, there should be one or two, maybe three.
4 – What type of advance you are seeking
Consider if the project(s) fit into one or more of the below:
Extend overall knowledge or capability in a field of science or technology; or
Create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or
Make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or
Use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way (e.g. a product which has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner)
The advance sought should be established at the beginning of a project and is not likely to change unless there is a significant failing in the project. If there is, it is likely you have closed on R&D project and moved onto another, so you should consider restarting this process for the next attempt. Though hopefully some of the core information will translate across.
Uncertainties Faced
This will have a phase during the start of the project and likely evolve or expand over the project’s lifespan.
From ascertaining what the market can do and what you are looking to achieve, you should have an idea of what areas of concern or deficiencies in current knowledge there are. Statements such as ‘how to get X to work with Y without doing Z’ can be used or could be more direct such as ‘how to develop A to provide B functionality’. This entirely depends on what you are trying to achieve.
Tip: During the project the uncertainties may grow or morph dependent on the work undertaken, noted below, any new or change of uncertainties should be documented as iterations of the project’s progression.
Work Done to Overcome Uncertainties
This area could be summarised as the story of the project, what work was done, what were your findings and how did that achieve your advance or impact your next steps.
HMRC will want to see evidence of work having been undertaken and recordings of results.
For example, if you are developing code, a screenshot of the coding generated, a file note explaining the tests done and its findings and the expected work from the outcome. This could lead to more similar files with new coding and test results.
Effectively, its keeping track of your progress and documenting where you are going next, which could be continuing in those steps or having to sidestep or even stop.
Tip: Failures can be a great show of R&D work done as it evidences the challenges faced.
You may be able to get some of this data from your staff timesheets, depends on how much information is stored at that level.
HMRC also like to see timelines for projects. Any made or corresponded about should be kept, with each iteration saved separately to show progression.
For all documentation, we’d recommend that it is date stamped or saved it in a non-editable form.
As with staff time, how you operate will impact how best to do this. This could be that you are requested to tender for a potential new client and as part of that you research what they need and what they already have, this would be prime information for the baseline segment.
Or it could be the job is internal to yourself and you employ a Competent Professional to lead the project, it could be stipulated that each element of the project is required to have some sort of summary document which includes R&D queries as well as other internally required information [due dates such like].
Your chosen R&D tax adviser will request this information from you and ensure it is documented to HMRC in the Additional Information Form. Depending on the number of projects per claim, you may expect your adviser to have one or more consultation calls with you to gather the information needed and then further information/ evidence is requested via email.
Summary
Ultimately record keeping is essential in making commercial decisions and especially to ensure full compliance and defend any potential HMRC enquiry.
Due to the introduction of HMRC’s Additional Information Form, it is critical that the information and evidence is available and can gathered from you by your chosen R&D tax adviser as this is the information that HMRC need to process your R&D claim. Without this information, your claim will be rejected by HMRC.
Our recommendation for small and medium-sized businesses is that the record keeping for R&D is inbuilt in your processes, so that in the end whenever R&D occurs it becomes second nature to record all the necessary information. Allowing you to continue striving for your other commercial goals whilst utilising the tax relief you are entitled to.
The greater the records, the more streamlined your R&D Tax Claim will be; saving you more time and energy in the long run.
What tips do you have for recording R&D projects? We’d love to hear yours! Put them in the comments section below.