Contractors are one of the qualifying expenses of R&D tax claims. This allows companies to rely on external experts while increasing the size of their available tax credit. However, there are some caveats and exceptions to the rule.

When a subcontractor or an Externally Provided Worker (EPW) is classed as “connected”, the qualifying expenditure is subjected to some unique rules. These often result in reduced credits – but it may not affect the ultimate benefit.

What Does ‘Connected’ Mean?

Companies may be classed as connected based on control and ownership. So two companies with the same shareholders are considered connected parties when considering subcontractor costs. These connections can also be extended through lineal family relationships – so if your sibling or parent or children own or control a company that you subcontract from.

Why do Connected-Party Subcontractors Have Special Rules?

The HMRC has designed the system this way to ensure only the actual cost associated with the R&D receives the uplift – an extra 130% deduction of qualified costs from a company’s yearly profit.

Unconnected subcontractors and EPWs require a notional 35% ‘profit margin element’ to be removed from the claim. This is considered ‘fair treatment’ But when the parties are connected, the notion of ‘fair’ becomes a bit trickier. 

What are the Special Rules?

The company can only claim R&D tax relief on the lower of:

  • The payment that it makes to the subcontractor
  • The relevant expenditure of the subcontractor

Example: Company X subcontracted work to Contractor Y, which they also own. Company X paid a sum of £100k, net VAT, to Contractor Y during the R&D period being claimed. This was entirely related to the development project in question. However, relevant expenditures incurred by Connected-Party Contractor Y were only £50k.

Company X can only claim £50k for R&D tax relief as that is the lower of the two amounts.

It is also important to note that the 65% cap found when dealing with unconnected subcontractors does not apply to connected-party subcontractors. This benefit can – in the right circumstances – more than make up for the negative effects of the connected-party rule.

Who We Are:

Swanson Reed is one of the UK’s leading R&D Tax Relief consultancies. We manage all facets of the SR&ED tax credit program, from claim preparation and audit compliance to claim disputes.

If you would like to find out more about how your business could benefit from R&D Tax Credit, contact a Swanson Reed R&D Tax Advisor today.