Understanding Subcontractor Guidance for R&D Tax Credits: 2024 Updates

Across 2023 and 2024, there has been significant change to the way R&D tax relief is claimed, and the level of robustness with which HMRC is processing those claims.

We have seen extra steps added to making an R&D tax relief claim including an additional information form and an advanced notification requirement. But most significant is the effective end of the SME R&D tax credit scheme for accounting periods commencing after 1 April 2024, with a merged RDEC scheme taking its place. This offers a lower rate of relief for SMEs than what they could once claim (albeit the new RDEC rate is higher than what it was previously).

Loss-making SMEs who perform intensive R&D (defined as spending more than 30% of their expenditure on qualifying R&D) have access to a new SME scheme called Enhanced R&D Intensive Support (ERIS) which offers an enhanced rate. It is now the most generous R&D tax relief scheme, but only a limited number of SMEs will qualify.

The rationale behind the changes is primarily to make claiming and administering R&D tax relief more streamlined: easier for companies to understand and harder for the scheme to be abused.

A further key change, introduced for accounting periods beginning after 1 April 2024 relates to who can claim R&D relief on subcontracted R&D.

Previous subcontractor guidance

Subcontracted R&D is when one company is paid to perform research and development on behalf of another.

Previously, using the SME scheme, an SME subcontracting firm could claim for 65% of the costs of any qualifying R&D it undertook as part of its agreement with the contracting firm.

Subcontractor costs were not admissible within RDEC, so if the contracting firm was a large company then it had no option to claim.

If the contracting firm was an SME, however, there was the potential for duplicate claims to be erroneously made and paid. You can read more on the old rules here if they are still relevant to you due to a current or previous accounting period (before 1 April 2024).

The new subcontractor rules seek to prevent this duplicated claim scenario.

New subcontractor guidance from 1 April 2024

The new subcontractor guidance reverses the above, in theory. It also now makes it less likely for duplicate claims to be submitted because companies will have to think more deeply about who an “R&D decision maker” is.

Applicable to both RDEC and ERIS, under the new guidance (at the time of publication this is not final), you need to look at who the R&D decision maker is – it is their company which is justified to make the claim. There is not a tight definition of this decision maker. The guidance uses language like “you will need to demonstrate that you intended or contemplated that R&D of the sort would be done”.

Examples

Some examples will help to explain the principle.

As a starting point, if Company A directly contracts Company B to carry out a specific R&D project, this should be pretty clear cut – Company A can include the relevant costs in an R&D tax relief claim should it choose to do so.

If, however, Company A contracts Company B to do a piece of work in which there is no obvious R&D; but then Company B identifies R&D is necessary as an internal process to that work; then there may be a case for Company B to claim any R&D tax relief available themselves.

In a further scenario showing a longer supply chain, you may have Company A commissioning Company B to deliver a project, and then Company B using the services of Company C to assist with a specific aspect of R&D. In this scenario, it may be argued that the R&D decision maker sits in Company B, so it is they that can make the claim.

The guidance suggests that if a contracting company shows a level of indifference as to whether or not R&D is performed that may be an indicator that the subcontractor can claim – it is them that is driving the R&D. It would be sensible to record this contractor indifference and subcontractor decision making as early as possible.

Overseas subcontracting

The other significant change relating to subcontracted R&D claims is that strict limitations are placed on claiming for overseas subcontracted R&D. In fact, the starting point is that these are not admissible in a claim. There are a few exceptions though, and the underlying principle for these is whether it would be wholly unreasonable to carry out the R&D in the UK. For example, if the R&D revolved around specific climate conditions which would be difficult to replicate in the UK.

The subcontracted claim rate

If you are working with an unconnected subcontractor, you (as a contractor) can claim 65% of a payment made for R&D. If your subcontractor is connected to you, the costs are subject to additional rules, but you may be able to claim up to 100% of the payment made for R&D.

Implications for businesses

For SMEs accustomed to claiming R&D tax relief under the old SME scheme, there is much to consider with all the changes that have been introduced. The value of your subcontracted claims forms an important part of this.

The new rules may effectively drive your costs up and so understanding this and reflecting it in your contract terms may have great commercial importance to you.

The rule changes will also require both contractors and subcontractors to think carefully about who the R&D decision maker is, what precisely they are asking for, who is bearing the risk, where any intellectual property lies and how this information is recorded to substantiate any claim.

The government’s intention is to get the R&D tax incentives going to the decision-making companies, therefore encouraging more R&D from the top of the supply chain. If this works correctly it should create more demand for innovation and so more custom for innovative SME’s. It should also give the UK a more competitive economy.

Best practice for claiming subcontractor costs

As we have always advocated, good record-keeping is essential for robust R&D tax relief claims. These new subcontractor rules put heightened focus on documenting all the decisions relating to R&D, and also precise contractual wording on these points.

You can study the HMRC guidance directly here.

It is essential to stay informed and compliant so that you can maximise your eligibility for tax incentives and continue driving advancements in technology and innovation.

While in some ways, R&D tax reliefs have been simplified, the case of subcontracted costs shows just how much value an expert adviser like Kene Partners can add. By working with us you can not only be confident that your claim will be submitted correctly and efficiently. But also, we can work with you in advance to help you optimise your position.

Why not book a free consultation or try out our free eligibility assessment?

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