Staffing costs

For most businesses, staff costs represent the largest part of a R&D tax claim.

You can generally claim:

• Gross salaries and wages
• Employer’s National Insurance contributions
• Employer pension contributions
• Certain bonuses linked to R&D work
• Reimbursed employee expenditure (to the extent that these are incurred for R&D and relate to R&D cost categories).

Where employees split their time between qualifying and non-qualifying work, only the R&D proportion can be claimed. For example, if a developer spends 70% of their time on eligible R&D projects, only 70% of their employment costs would normally qualify.

Good record keeping is essential. HMRC expects businesses to be able to justify time apportionments using evidence such as:

• Timesheets
• Sprint records
• Jira or DevOps logs
• Project plans
• Technical meeting notes
• Managerial assessments

Exclusions

Non-cash staff benefits must be excluded. Examples include vouchers, car benefit (rather than cash benefit for car), redundancy payments, un-excercised share options etc.

Key points to note

• Individuals whose staff costs are being claimed should have their employment contracts with the claimant company.
• Only tax-deductible expenditure may be claimed. Consider timing of pension payments, bonus payments etc, to ensure these are tax-deductible for the claim period.
• There is NO restriction on claiming for non-UK R&D undertaken by staff.

Externally Provided Workers

Externally Provided Workers are individuals supplied by a staff provider, such as:

• Agency workers
• Contractors
• Freelancers engaged through a provider

To qualify:

• The workers must operate under the claimant company’s supervision, direction, or control.
• Other conditions also apply.
• The work must relate directly to eligible R&D.

• There must be a payment for ‘qualifying earnings’ to a staff provider or staff controller for the contractor personnel. This generally means the claimant company must pay a staff provider for the services of individuals who are supplied to work on the company’s R&D activities.
• The staff provider is typically responsible for paying the worker’s earnings and operating PAYE and National Insurance where applicable. Therefore in most cases, the EPW’s earnings must be subject to UK PAYE and National Insurance for the costs to qualify. Exceptions apply. (see below for exemptions noted in the ‘Contracted-our R&D section below.For unconnected EPWs, claims are typically restricted to 65% of the relevant payment.
• You can claim upto 100% of relevant payments for eligible R&D to connected staff provider/controller (e.g group company or any other company where an election is made to be treated as connected).

Contracted-out R&D

R&D is defined as contracted-out where it is reasonable to assume that the customer/payer intended or contemplated that R&D would be done. Such a contract might cover an entire commercial project (including R&D and other activities), an entire R&D project or aspects of an R&D project.

Qualifying Costs

• For payments made to unconnected contractors/subcontrators, the claim is restricted to 65% of the qualifying payment.
• Where the claimant and the contractor/subcontractor are connected parties, the full amount of qualifying expenditure is claimable.

Contracted out/Subcontracted R&D remains one of the most technically complex areas of the UK R&D tax relief regime and is now governed by substantially revised rules for accounting periods beginning on or after 1 April 2024.

Under the post-April 2024 framework, entitlement to claim relief for subcontracted R&D is determined primarily by identifying which party has contracted out the R&D and which party is intended to bear the economic and technical risk associated with the work.

HMRC now focuses heavily on the commercial substance of the arrangements rather than simply the contractual wording. Key considerations include:

• Which party initiated or intended the R&D activity
• Which party defined the objectives and scope of the work
• Which party bore the financial and technical risk
• Which party had responsibility for resolving the scientific or technological uncertainties
• Whether the subcontracted activities formed part of another company’s R&D project

In broad terms, where a company contracts another party to undertake R&D on its behalf, the customer company will usually be entitled to claim relief, rather than the subcontractor performing the work.

HMRC continues to distinguish between:

• Contracting out qualifying R&D activities, and
• Purchasing standard goods or routine commercial services

Routine services that do not directly contribute to resolving scientific or technological uncertainty will generally not qualify.

Overseas restrictions and exemptions

Overseas restrictions apply to EPW and contracted-out R&D expenditure. In most cases, overseas EPW and subcontractor costs will not qualify unless the company can demonstrate that the R&D activity must necessarily be undertaken outside the UK due to:

• Environmental conditions
• Social or population-specific requirements
• Legal or regulatory requirements

HMRC expects businesses relying on these exemptions to retain robust contemporaneous evidence explaining why the activity could not reasonably be carried out in the UK.

Given HMRC’s increasing scrutiny of subcontracted R&D claims, businesses should maintain detailed supporting documentation, including:

• Technical specifications and project scopes
• Evidence of project oversight and decision-making
• Correspondence demonstrating responsibility for the R&D
• Financial records supporting cost allocations
• Evidence supporting any overseas exemption claims

Careful analysis of EPW and subcontracted arrangements is now essential to determining entitlement to relief and preparing a compliant and defensible R&D tax claim.

Consumables

• Consumables such as raw materials, test materials or items (e.g chemicals used in testing) employed directly in R&D may be claimed.
• The expenditure must be on items used in the R&D and no longer useable in their original form as they will be finished up or transformed.

• Where the consumable items, prototypes or first-in-class items are sold/ownership is transferred (at arms length), these costs CANNOT be claimed. For example, a prototype destroyed during testing may qualify, but if this is sold at arms length, it will not qualify. Businesses should retain clear records linking consumable costs to specific R&D activities or experimental phases.

• Qualifying cosumable expenditure includes the costs of water, fuel and power.

Software

Software used directly in qualifying R&D can often be included in a claim.

Eligible software expenditure may include:

• Development environments
• Simulation software
• CAD tools
• Technical modelling platforms
• Testing tools
• Specialist analytics software

Where software is only partly used for R&D, a reasonable apportionment should be applied.

For example:

A cloud development platform used 80% for experimental software development may be claimed at 80%

General business software used mainly for administration would usually not qualify.

Data licences and Cloud computing

Modern R&D increasingly relies on cloud infrastructure, datasets, and computational environments. Qualifying expenditure can include:

• Cloud hosting used directly for R&D

• Data processing environments
• Compute infrastructure
• Virtual machines
• Data storage for R&D activities
• AI and machine learning datasets
• Data licence fees

This category is especially important for:

• SaaS businesses
• AI and machine learning companies
• Software developers
• Data-heavy engineering businesses

However, cloud and data costs relating to general commercial operations or qualifying indirect activities must be excluded.

Businesses should therefore separate experimental environments, testing infrastructure and R&D datasets from production hosting, customer-facing systems, general IT overhead etc.

Payments to clinical trial participants

Life sciences and pharmaceutical businesses may claim payments made to clinical trial volunteers where the expenditure relates directly to qualifying R&D activity.

Where payments are not paid directly to the participants, but routed through 3rd parties (NHS, Universities etc), these are non-qualifying.

This category is specialist and generally requires detailed supporting documentation.

How we can help

The rules around the calculation of qualifying costs are quite nuanced for certain cost categories. HMRC scrutiny of R&D tax claims has increased significantly in recent years and may request for supporting detail such as:

• Invoices
• Financial reconciliations
• Payroll evidence
• Contractor agreements
• R&D cost allocation methodologies
• Clear cost schedules

Whether you are preparing your first claim or reviewing an existing process, our team can help identify qualifying expenditure accurately and maximise relief while maintaining compliance.