When I look at a detailed set of accounts one of the first thing I look for are the staff costs. This makes up the largest element of nearly every R&D claim. Better still as the government wishes to encourage employment the “rules” around claiming staff costs are quite favourable. I will give some detail below. But a lot of the concepts require further knowledge. For example, I will not look at what qualifying R&D activity is. That is a large subject by itself. A lot of detail is involved in R&D claims and to get them right it is always best to get detailed advice specific to your circumstances.
Key points of detail on staff costs.
To claim any R&D qualifying expenditure it must be allowable as a deduction in computing the profit or loss for the accounting period being claimed. If expenditure is accrued, it must be paid at the time the R&D claim is made.
You can claim the staffing costs of directors and employees actively engaged in qualifying R&D. This includes those directly doing R&D and those indirectly supporting it. You can claim 100% of the cost relating to R&D activity. This is more beneficial than some other R&D costs-types.
Other commonly claimed cost-types, that relate to people doing R&D, are unconnected subcontractors and unconnected externally provided workers (EPWs). In the case of either of these, you must discount the relevant cost to 65% i.e. if 70% of time or cost involved R&D activity you have to reduce this to 65% of 70%. Whereas with staff you can claim the entire amount that relates to the R&D activity, i.e. in this example the whole 70%.
Furthermore, in respect of direct R&D activity and indirect supporting activity done by subcontractors and EPWs, you can only claim the expenditure that relates to direct R&D activity, not indirect support activities. In terms of R&D claims staff on the payroll are more beneficial in these two ways.
Definitions are also much clearer in terms of being a member of a staff. You have a contract of employment and if taxes are due the company administers them. Definitions around subcontracting and EPWs are far “catchier”. Particularly around IR35 type issues. For example, a Director in the claimant company cannot be claimed as an EPW at all. This is all due to the government favouring employment and the collection of tax through employment over personal services companies or self-employment.
The expenditure you can claim is the total remuneration relating to the employee. Generally, this is their gross salary plus employer NIC contributions and employer pension contributions. You cannot claim benefits in kind like a company car or health insurance that the company pays for its employees. Expenses incurred by staff while conducting R&D activity can be claimed providing it is paid by the employee and reimbursed by the company to the employee, but not if it is directly paid by the company.
Lastly, in this brief examination of staff costs it is important for shareholders in companies to understand that dividend payments are not allowable expenditure in computing the profit or loss for taxation. They come from the post-tax profits and are not claimable as an expense in an R&D claim, because they are not an expense of the business.
Impact of Furlough
Sometimes when giving tax advice you must state the blatantly obvious. Expenditure related to R&D involves activity. Being on furlough means staff are inactive. Staff cannot be doing R&D activity while on furlough. To have staff working while on furlough would be fraud. If a member of staff has total remuneration of £3,000 a month, and 50% of their time involves R&D activity, and they worked for 9 months in an accounting period and spent three months on furlough the calculation would be:
9 months working x £3,000 = £27,000 x 50% = £13,500.
A big danger exists in claiming 12 months x £3,000 x 50%. That would be incorrect.
HMRC will be looking for this issue as they should on any issue around the incorrect amount of tax and tax-payer funds. HMRC have the furlough scheme records. They have already made the point to the consultancy industry, through the R&D consultative committee, that staff costs must be measured correctly. Companies claiming R&D Tax Credits or Relief need to handle this issue correctly. It involves quite a simple principle about activity versus inactivity.
This has been a brief tour of one area of R&D qualifying expenditure. Perhaps the most straightforward to deal with. R&D claims involve a lengthy set of guidelines and legislation. If you have any questions, please get in touch.
Christopher Toms MA MAAT – Director RandDTax.