One of the questions I am asked most often is whether a company can include all of an employee's salary within an R&D tax relief claim.
It is an understandable question. Many companies employ scientists, engineers and software developers specifically to undertake research and development. If someone spends their career solving scientific or technological problems, it seems reasonable to assume that all of their employment costs should qualify.
Sometimes that is the correct answer, but more often it is not.
The reason is straightforward. The legislation does not look at employees. It looks at activities. Understanding that distinction makes it much easier to calculate staffing costs correctly and avoid problems if HMRC later reviews a claim.
It is the activities that matter
The Guidelines on the Meaning of Research and Development for Tax Purposes explain that qualifying R&D consists of activities that directly contribute to achieving an advance in science or technology through the resolution of scientific or technological uncertainty.
That means the starting point should never be an employee's job title or the department they work in. Instead, it should be an assessment of what they actually spent their time doing during the accounting period. Two employees with exactly the same role may therefore have different qualifying percentages because their day to day activities differ.
Even employees recruited specifically to undertake R&D will often spend part of their time on activities that fall outside the scope of qualifying work. They may provide routine production support, undertake routine regulatory compliance activities, attend commercial meetings or carry out general administrative duties. Those activities would not normally qualify because they do not directly contribute to resolving scientific or technological uncertainty.
On the other hand, there will be occasions where all of an employee's employment costs can legitimately be included. If an employee spends all of their time either directly undertaking qualifying R&D or carrying out qualifying indirect activities in support of that R&D, then claiming all of their employment costs may be entirely appropriate. The important point is that this should be the conclusion reached after considering the employee's activities. It should never be the starting assumption.
Looking beyond the obvious R&D work
The same principle helps answer several other questions that regularly arise.
Planning is a good example. Many people assume planning is automatically excluded from R&D tax relief. That is not the case. Planning that directly contributes to resolving scientific or technological uncertainty may qualify. The Guidelines include activities such as defining technical objectives, assessing technical feasibility, estimating development time and resources, and planning the scientific or technical work needed to resolve the uncertainty.
By contrast, commercial planning, market research, financial planning and legal work do not qualify because they do not contribute to resolving the scientific or technological uncertainty.
Holiday pay and sick pay are another area that often causes uncertainty. HMRC's guidance accepts that these costs should generally follow the same apportionment as the employee's qualifying activities. If 70% of an employee's work qualifies, then 70% of their salary, employer's National Insurance, pension contributions, holiday pay and sick pay would normally be included. If all of their activities qualify, those associated employment costs would normally also be included in full.
Viewed in this way, the answer becomes much simpler. The employment costs follow the qualifying activities.
A cautionary tale
Several years ago, a company approached us for help with an HMRC compliance check. They had been claiming R&D tax relief for around six years and believed the enquiry into their latest claim had gone well until the end.
The only significant issue HMRC had raised was staffing costs. Every member of the technical team had been treated as spending all of their time on qualifying R&D. In other words, every employee had been claimed at 100%.
After discussing the employees' actual activities, the company accepted that this did not accurately reflect the work being carried out. An apportionment of 80% was agreed for the year under enquiry. Although disappointing, they understood HMRC's point and felt it was a reasonable outcome.
Then, just as everyone thought the compliance check was coming to an end, the inspector made one simple observation.
“If 80% is the correct figure this year, could you also reduce your previous five claims where you treated the same employees as spending 100% of their time on qualifying R&D?”
Suddenly, what had appeared to be a relatively modest adjustment became a much bigger issue. The discussion was no longer about one accounting period. It was about six years of claims that had all been prepared using the same assumption.
By the time the company contacted us, the compliance check was effectively over. They had accepted that the revised percentage reflected the facts and, in our view, it was the correct technical outcome. There was very little we could do to help because the issue was no longer about technical arguments. From almost any perspective, the company had overclaimed its staffing costs and it seemed reasonable that HMRC should seek to correct that position. As a tax payer I would expect them to do that.
I still tell this story because it demonstrates an important lesson. The percentage attributed to an employee is not simply a figure used to maximise a claim. It is a judgement that should reflect reality and be capable of being justified several years later if HMRC asks how it was calculated.
Final thoughts
When considering staffing costs, I encourage clients not to ask whether someone is a “100% R&D employee”. Instead, I suggest asking a different question:
What qualifying R&D activities did this employee actually undertake during the year? What did they do that was not qualifying R&D?
Once that question has been answered honestly, the appropriate percentage usually becomes much clearer.
A claim built on realistic, evidence based assessments is not only more robust, it is also much easier to defend if HMRC opens a compliance check several years later.
If you would like advice on calculating staffing costs, or you would like an independent review of your R&D tax relief claim before it is submitted, we would be pleased to help.
Contact us: https://www.randdtax.co.uk/contact/
Christopher Toms MA MAAT
Compliance Director
RandDTax