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What Costs Can Be Claimed in an R&D Tax Claim?

For small and medium-sized enterprises (SMEs), R&D tax relief can be a game-changer, helping to reduce tax liabilities or even providing a cash boost to reinvest in innovation. Whether you're developing new products, streamlining processes, or solving complex technical challenges, understanding which costs qualify is crucial to making the most of this valuable incentive.

Many SMEs miss out on claiming their full entitlement simply because they’re unsure what expenses are eligible. Knowing which categories you can claim for is the first step.

Companies can claim for the following exhaustive list of cost categories:

• Staff Costs
• Subcontractors (or contributions for independent R&D for RDEC claims)
• Externally Provided Workers
• Software Licenses, Data Licenses and Cloud Computing
• Consumable Items
• Clinical Trial Volunteers

There are rules and caveats to each category; understanding these details will help you make the strongest claim and avoid spending time defending your claim in the event of a compliance check.

You must apply a reasonable apportionment when a certain cost was only partially used in R&D; the method you use to do this will change depending on the cost.

It’s common for an R&D team to be made up of many individuals from different parts of the business. Typically, an R&D project team may include staff such as:

• Directly contributing activities undertaken by engineers, developers, technicians, scientists, etc.
• Supervisory activities commonly performed by team leaders, department managers, and product managers.
• Senior management, such as the chief technical officer, may work directly on qualifying activities, especially for small businesses.
• Staff members involved in indirect supporting activities such as technological research, project costing, HR recruitment, and administration.

HMRC expects companies to maintain accurate records regarding staff time spent on qualifying R&D activities, ideally through timesheets, although estimates are okay if they have some evidentiary basis.

For staff working directly on the R&D project, you can claim for the following costs:

• Salaries/wages
• Bonuses
• Pension fund contributions
• Secondary Class 1 National Insurance contributions paid by the company
• Reimbursed expenses that were made for carrying out the R&D activities. The employee needs to pay for the qualifying expenses and make an expense claim for them to be included in the R&D tax claim. 

Directors’ pay and R&D tax relief claims

In many start-ups and small companies, the directors choose not to draw a salary and instead receive dividend payments. This may be helpful when it comes to tax season for the individual, but small companies undertaking lots of R&D which the director is heavily involved in may wish to consider the benefit of claiming that salary.

For the avoidance of doubt, this article refers to the company that contracts or subcontracts work to another company as the “contracting party” and the company that is contracted or subcontracted as the “contractor”.

In all industries, companies need to make commercial agreements to deliver innovation. Contracting out elements of projects, or even the entire project, is easier, faster, and often more cost-effective than taking on those tasks in-house without the needed expertise.

Importantly, companies claiming through the RDEC Scheme cannot claim for any subcontracted costs unless it is undertaken by:

• a qualifying body (for example, a charity, higher education institute, scientific research organisation or health service body)
• an individual
• a firm where each member is an individual

Connected versus Unconnected

The rules around contractor and externally provided worker costs can be very complex.

If the contractor is not connected to the claimant company, 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.

However, the rules are complicated for connected parties; you can only include eligible R&D expenditure at cost value (i.e., without markup).

Right to claim

With the introduction of the Merged Scheme for accounting periods beginning on or after 1 April 2024, there has also been a change to how to determine which company has the right to make an R&D tax claim for work done within a contracting arrangement.

The general principle is that the company deciding to initiate the R&D gets relief from that expenditure. Where the contracting party “intended or contemplated” R&D to be carried out by the contractor, it can claim for the contracted-out R&D.

For more details on this tricky topic, check out our article on the right to claim.

The rules were vaguer under the SME scheme. Companies cannot claim for R&D work they did that was subsidised. This usually means that contractors cannot claim for any R&D they do on behalf of another company, as they do not take on the risk of the project.

However, HMRC has made a recent effort to clarify the rules following multiple losses at First-Tier Tax Tribunal. Largely, SMEs may claim for R&D that they undertake within a contracting agreement, so long as it does not form part of the original contract and is taken at the company’s risk.

This category of qualifying expenditure includes cases where a staff provider, such as an employment agency, is contracted to supply external workers for the R&D work.

Externally provided workers, or EPWs, must meet the following criteria:

1. The worker is an individual, not a company.

2. The worker is not a director or employee of the claimant company.

3. The worker personally provides services to the claimant company.

4. The worker is under the claimant company's supervision, direction or control.

5. The worker’s services are supplied to the claimant company by a staff provider (the worker may be a director or employee of the staff provider).

6. The worker provides those services personally to the company under the contract terms between the worker and the staff provider.
7. The provision of services is not contracted out by the claimant company.

An easy way to check whether the conditions are met is to ask the staff provider if it operates PAYE for its workers. If so, we can assume that conditions 3 to 7 are met.

Unconnected EPW costs are capped at 65%, like unconnected contractors. Likewise, connected EPW costs may be included up to the cost value of the invoice.

Claims can include the cost of software directly employed in the R&D activity. Software costs can also be included if they are involved in any qualifying indirect activities.

Where software is only partly employed in direct R&D, an appropriate apportionment should be made. The type of apportionment will depend on the software. For example, an apportionment based on the ratio of R&D staff time to non-R&D staff time may work, or the number of licenses used by staff involved in R&D projects, compared to those who are not, may be more accurate.

Cloud Computing & Data Licenses

For accounting periods starting on or after 1 April 2023, data licence and cloud computing services costs can be included in an R&D tax claim.

A data licence is a licence to access and use a collection of digital data. Cloud computing includes data storage, hardware facilities, operating systems and software platforms.

Once again, an apportionment is expected to identify how much of their use contributes to resolving scientific or technological uncertainty.

You can claim for the cost of items directly employed, transformed, or consumed in qualifying R&D projects. These include materials and the proportion of water, fuel, and power consumed in the R&D process. For manufacturing projects, this may consist of further tools or materials used to develop prototypes.

As with all cost categories, reasonable apportionments should be made where an item was only partially used in R&D. For example, the claimed cost of heat and power may follow the ratio of R&D staff time to non-R&D staff time (i.e., where 50% of total staff time was R&D, 50% of the costs of heat and power are included).

However, the costs of materials incorporated in products that are later sold are not eligible for relief. For example, if a prototype is developed as part of an R&D project but is eventually sold, the cost of its materials cannot be claimed, as the company would benefit twice from the cost of the item.

For R&D projects in the pharmaceutical industry, you can claim for payments made to the subjects of clinical trials. HMRC expects R&D to be involved in the drug discovery phase, preclinical development, and phases I to III of clinical trials (although it is less likely to be involved in phase IV). Clinical trials involve testing the drug on healthy individuals and patients with a specific disease or condition.

As volunteers are not staff, contractors or EPWs, nor can they be considered consumable items, their costs are in their own category.

We’ve compiled a full deep dive into the minutiae of making an R&D tax credit claim, which you can download for free: Download here!

This eBook goes into more detail on each of these categories, with examples and tips for making a maximised claim.

If you have any questions that aren’t answered here, get in touch with the experts. We’re always happy to chat R&D tax credits!