The 5 Most Common Mistakes with R&D Tax Credit Claims
The consequences of mistakes in your R&D tax credit claim can vary depending on the type of mistake made, but it is better to avoid making errors from the outset than to try and fix them later.
Avoiding tax claim errors is vital in order to ensure that your organisation is properly and accurately rewarded for its research and development activities. To do so, it’s important to be aware of some of the most common errors in R&D tax credit claims.
Here are five R&D tax claim mistakes that people often make when filing their reports.
Claiming under the wrong scheme (SME vs RDEC)
One mistake that people often make is claiming under the SME scheme instead of RDEC. This mistake could result in ineligible expenditure types being included, as well as errors in the corporation tax numbers in the Statutory Accounts and the way the R&D benefit is reflected in the Statutory Accounts. Let's take a quick glance at the differences between the two schemes...
The SME scheme is currently much more generous than the RDEC scheme in terms of the tax/cash benefits delivered via an R&D tax credits claim. Rates of relief can result in financial benefits worth between 25% and 33.35% for every £1 of qualifying expenditure identified. Under RDEC, by comparison, the tax/cash benefit is currently 10.53% for every £1 of qualifying research and development expenditure.
To understand which scheme applies to your organisation, there are a number of aspects that need to be considered collectively. One of these aspects is a set of rules and considerations referred to ceiling threshold tests. Exploring ceiling tests starts with looking at some headline thresholds, but there can be added complexities to consider in the application of these to determine eligibility for R&D tax credits!
Claiming for non-eligible aspects of a project
Just because a project qualifies as R&D, doesn’t mean that all the activities associated with that project can be included in your R&D tax credits claim.
The BEIS guidelines set out the boundaries of R&D as a framework for qualifying activities. It’s extremely important to get these boundaries right as qualifying activities form the foundations for identifying and linking qualifying expenditure.
As a general principle, R&D starts with those activities to define and set the scientific or technological specifications for the project and ends at the point a project has met the scientific or technological intent.
Common mistakes often occur around the periphery of these start and end phases, mostly owing to the misunderstanding of the context of ‘research’ for R&D purposes.
Not all activities can be claimed in relation to a qualifying R&D project. For example, you cannot include:
- Business or commercial activities prior to the identification of a project, which did not involve any R&D.
- Business or commercial activities that do not involve any R&D nor contribute directly or indirectly to a qualifying R&D project. For example, there should not be any ‘general R&D’ catch-all headings included in an R&D tax credits claim.
- Any type of preliminary market research (not to be confused with focus groups to progress technological specifications). This includes research for SEO, market segmentation, customer feedback on ideas, etc. These activities are considered to be pre-R&D.
- Validation testing, trial production runs, and routine troubleshooting/optimisation of equipment/routines. These activities are considered to take place after the project has overcome technological uncertainty. If issues arise then another phase of development may commence.
- Routine work where no technological or scientific uncertainties existed. The activities need to collectively, directly or indirectly, contribute to the advances sought.
- Scientific or technical reviews where activities do not contribute to a qualifying R&D project. For example, where your company has used only its past experience and know-how to complete the work.
- Activities associated with the wider build of equipment or systems that feature in the end saleable product. Due consideration is required to the First of Class principles for builds that include R&D where it is not viable to first build and test a series of prototypes.
Not keeping an accurate record of R&D-related expenditure
When preparing a claim for R&D tax credits, you will need a robust audit trail to establish:
- Proof of costs (invoices)
- A clear link between the qualifying activities and the underlying costs incurred
- In some cases, tracking of where costs are included in the accounts and any deviation from tax treatment, for example, costs brought into account as an intangible fixed asset subject to a s1308 CTA 2009 claim to facilitate the inclusion of costs in the R&D claim.
Often, an organisation fails to consider and record how it has sought to link its expenditure to the qualifying work, particularly where R&D is considered retrospectively rather than contemporaneously. Where systems for accurate accounting of costs to specific R&D codes and time recording records are not in place, processes and methodologies should be formulated to extrapolate R&D expenditure from underlying costs on what HMRC refers to as a “just and reasonable” basis.
A “just and reasonable” basis is not some kind of HMRC approved methodology - HMRC does not have an approved methodology or list of acceptable approaches, each claim is assessed on its own merits/fact patterns.
This means that HMRC will consider your approach and either agree or question its integrity. In this instance, descriptions, explanations and transparency are key to demonstrating that fair apportionments have been made. Broad-brush, high-level allocations of percentages with no attempt to link to projects via logic and just and reasonable methodologies are not acceptable.
Where possible, you should try to implement processes within your organisation that allow for accurate record-keeping. The source data should be retained with your records of projects and accounting data and supporting invoices as an audit trail that you can present to HMRC should they wish to check on this. Most claims will involve a mix of specific R&D cost capture and just and reasonable apportionments.
For first-time claimants, it is understandable that detailed records and logs have not been kept. But by working with a specialist tax adviser to formulate a prudent cost attribution approach, you can introduce processes to capture the required data more closely going forward to use in future claims.
Misunderstanding qualifying expenditure
There are 2 overarching areas of qualifying expenditure for R&D tax credits - in-house and outsourced costs. Under these, there are broadly 5 further areas associated with R&D activity, covering staffing, resources and utilities:
I regularly find mistakes across all qualifying expenditure categories. Below is a list of the most common:
1. Staffing costs
The opportunities here are broader than simply claiming for the salaries of staff associated with your R&D project.
Tax technical point: Qualifying staff costs must meet the definition of an “emolument” per relevant tax legislation.
Based on this, it is incorrect to include benefits in kind such as a company car, however cash allowances are fine.
Reimbursed expenditure (e.g. a hotel charge or train ticket fee), provided it is directly related to qualifying R&D activities, but costs met directly by the company (invoices settled directly or paid for via a company credit card) are not allowable. Some organisations may look at changing to reimbursement but watch out for the P11D reporting requirements if you are considering making changes here.
2. Externally provided workers
It’s not uncommon for organisations to hire competent professionals to support their internal workforce. However, this category is often misunderstood, with third-party workers being included in R&D tax credit claims under the subcontractor category, when actually, the facts around the working relationships mean that those costs fall within the externally provided worker category.
Whilst both categories are subject to the 65% restriction once qualifying expenditure attributable has been identified, it is important if you are a large company or are an SME that subsequently becomes large. This is because under RDEC – the scheme for large companies - you cannot claim for subcontracted activities, but you can claim for externally provided workers.
The other error I find here is the inclusion of recruitment agency fees that cannot be claimed.
3. Software & Consumables
Mistakes here are mostly around failure to exclude an element of the costs attributable to help and support; or around including software that is too far removed from supporting qualifying R&D activities.
Many claims also wrongfully include a one-off capital purchase of a software license, the license fees need to be revenue in nature and incurred on an ongoing basis (monthly/annually).
For manufacturing or engineering-based claims, in particular, there seems to be confusion around whether a cost falls under a subcontracted specialist activity or can in fact be included as a consumable item. Failing to recognise this distinction means losing value in the R&D tax credit claim of 35% of the cost.
4. Water, fuel & power
This category tends to require a methodology to apportion gas, electricity and water costs to R&D activities. There are many different ways an organisation could look at doing this depending on their activities, number of sites and where the staff carrying out the qualifying work are based.
Achieving something sensible here will be organisation specific - a manufacturer would approach this very differently to a software development company for example.
Problems in this category tend to be the adoption of a broad brush basis that does not seek to exclude costs supporting wider organisational activities or is skewed towards production because of large energy demands during production.
5. Subcontracted activities
Subcontracting R&D activities means that you have commissioned someone outside of your organisation to carry out part of your R&D project. For example, testing activities.
The subcontracted work does not necessarily need to be an R&D activity itself but it does need to be part of a wider R&D project undertaken by your organisation. And, importantly, your organisation must retain the overall financial risk associated with the project.
Waiting too long to file for an R&D tax claim
The entire process for putting together your R&D Tax Credits claim can take time depending on the size and complexity of your claim. You will also need to wait for your company accounts and tax return to be prepared as the claim is included as part of the company tax return.
Typically, HMRC looks to generate tax refunds or payable credits from submitted claims within 28 days of submission, but this can vary depending on the complexity of wider organisational tax affairs in some instances. The sooner you start the claims preparation process, the better. Not only will it be ready to factor into corporation tax payment advice but the information recall in terms of qualifying project work will be easier as it is more recent.
It's also important to note that a company has 2 years from the end of its accounting period to file an R&D tax credits claim with HMRC. Don't worry if you have already submitted your company tax return (CT600) for the year in which you carried out R&D activities. You can amend your CT600 to include an R&D tax credits claim for up to one year from its filing deadline.
Another important consideration is your company tax return filing deadline - this may be different from the chargeable accounting period for the tax return (for example, a long period of account) so it’s worth checking if you are still in time to claim.
I help many first-time claimants prepare two R&D tax credit claims at the same time, supported by a single R&D tax credits claims report, to bring them right up to date quickly and maximise the financial benefits.
If you're ready to get started on yours, book a call to discuss your R&D eligibility.