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Claiming for Connected Party Costs in an R&D Tax Claim

Companies will often need to make commercial agreements to deliver innovation. It’s easier, faster and usually more cost-effective to contract out some of your R&D, or even the entire project, than to take on those tasks in-house without the needed expertise.

Most subcontractors or externally provided workers will be unconnected. This means that companies can only claim 65% of their costs, to account for the third-party mark-up.

However, connected subcontractors or externally provided workers are eligible too, at 100% of the cost in many cases. Knowing how to identify a connected contractor and whether they can be claimed can be a tricky subject in R&D tax relief.

There are three cost categories which may include costs to connected parties:

• Subcontractors
• Externally provided workers
• Contributions to independent research

A connected party is a company that is linked to the claimant company through shared ownership or control. Some companies may use the services of a connected party to control costs, or due to the structure of the group.

Claimants need to be careful when claiming for connected party costs, as companies may not claim the mark up applied by third parties (hence, the 65% cap on unconnected costs).

In most cases, companies can claim for the whole of their connected cost.

A company is connected to the claimant company if:

• The same person has control of both companies
• Connected people have control of the companies; connected people are:
  • Spouse or civil partners
  • Relatives
  • Spouses or civil partners of relatives
  • Spouses or civil partners of relatives of spouses or civil partners
• They are partners in a partnership (or connected to a partner)
• A joint election is made

A company may elect to be treated as connected with the contractor by making a joint election. This can be done by writing to HMRC within two years from the end of the accounting period in which the contract was entered into.

It is important to note that payments to a contractor who is also a company director cannot be included in an R&D tax relief claim.

More details can be found in HMRC’s guidance on the topic; alternatively, our team is happy to discuss your case in further detail.

When a company incurs costs through transactions with connected parties, those costs must exclude the amount of the connected party's profit. However, this is not the case if the transaction is priced “at arm’s length”, i.e., at a standard rate for the connected party.

The rules are complicated for connected parties, and a “look-through test” needs to be undertaken to determine the actual costs incurred. This means that you have to look at the work undertaken by the connected party and only include eligible R&D expenditure at cost value (i.e., without markup).

Companies must declare all the companies that are connected to them for at least one day within the accounting period.

Aside from the above, there are other considerations for companies claiming R&D tax credits:

• The rules around subcontractor and externally provided worker costs are changing. For accounting periods beginning on or after 1^st April 2024, companies will find that they can only claim for UK expenditure; this means that staff, contractors and externally provided workers must complete their R&D work in the UK to qualify. This applies to all companies and all workers, regardless of whether the companies are connected or the nationality of the worker.
• For unconnected subcontractors, the cost is always capped at 65% of invoice value to account for the markup of an invoice from a third party. This means that if 100% of an invoice is R&D, only 65% can be claimed. If only 50% is R&D, then 32.5% (or half of 65%) can be claimed.
• Companies connected with other companies need to ensure that they are claiming through the right scheme. Your company size is determined by the financials of the total group; this can impact whether you claim through the SME scheme or RDEC scheme or, if claiming for periods starting after 1^st April 2024, whether you can claim through the ERIS scheme. Knowing whether your companies are linked, partnered or connected at all can seriously impact your claim.

Still not sure if you can claim your connected costs? Want some assurance on your company size? Get in touch with our expert team!

We’ve been making claims for over 20 years; if you’re looking for someone to take on the heavy lifting for your claim, or just want to check your eligibility, Tax Cloud is your trusted partner.