When carrying out R&D projects, many companies subcontract elements of the work to external specialists. The way these costs are treated in your R&D tax credit claim depends on several factors including the size of your business, your relationship with the subcontractor, and who holds responsibility for the R&D work.
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Understanding subcontractor relationships in R&D claims
When making a claim, it’s important to take into account the relationship between the subcontractor and the contractor, specifically where they are working to overcome uncertainty.
It is essential to make sure that the costs you’re including in your claim are for qualifying R&D activities. To establish this, several factors need to be considered:
Autonomy and supervision
The autonomy and supervision in the relationship between the contractor and the subcontractor is a crucial aspect. A low level of autonomy combined with high levels of supervision could indicate that the relationship should be classified as an externally provided worker, rather than a subcontractor.
Nevertheless, when an SME is subcontracting qualifying activities, the subcontractor must have a certain degree of autonomy to resolve uncertainties effectively.
Deliverables and scope
When commissioning a specific part of an R&D project to a subcontractor, the deliverables must be carefully specified. It is important to have in-depth knowledge of the development area and to provide detailed specifications of the work that needs to be carried out.
Intellectual property (IP) ownership
In most cases, when R&D is subcontracted, the intellectual property (IP) is expected to belong to the principal company (“the contractor”). However, this is a complicated issue and cannot be conclusive when determining the nature of the relationship between the contractor and the subcontractor.
Risk and responsibility
When it comes to subcontracted R&D, the subcontractor is typically compensated based on the deliverables provided, paid on a milestone or fixed fee basis. As a result, it is important to know what risk falls on the principal company rather than the subcontractor and vice versa.
Once you have assessed these criteria and determined that the subcontractor is performing qualifying R&D activities, you can include the subcontracted costs in the claim.
Subcontractor costs under the SME R&D tax credits scheme
In an SME R&D tax credit claim, rules for claiming subcontractor costs differ depending on whether the subcontractor is connected or unconnected to your company.
Unconnected subcontractors
If your business is unconnected from the subcontractor, you can claim up to 65% of the costs – provided they relate to qualifying R&D activities and are proportionate to the work subcontracted.
Connected subcontractors
If the subcontractor is connected to your business, you can claim the lower of:
- The amount you paid the subcontractor, or
- The subcontractor’s qualifying expenditure for that work
What does ‘connected’ mean?
A connected subcontractor is one where the two businesses have a relationship through ownership, control, or family ties (for example, shared shareholders or relatives involved in both entities).
Subcontractor costs under the RDEC scheme
Companies claiming under the RDEC scheme face tighter restrictions on what subcontractor costs can be included.
You can only claim costs paid to specific qualifying entities, such as:
- Individuals
- Charities
- Higher education institutions
- Scientific research organisations
- Health service bodies
Many contractual relationships you might consider to be subcontractors could actually be classed as externally provided workers (EPWs) under RDEC. These can be eligible but the distinction is highly nuanced so it’s important to assess each relationship carefully and seek expert advice if you have large amounts at stake.
What Counts As Qualifying Expenditure?