Staffing Costs: Common pitfalls for R&D tax credits

R&D tax credit claims are driven by what is posted to your company's financial accounts in a given accounting period (and in some cases, how you treat certain costs).

This tax incentive is led by available 'qualifying expenditure'. If you don't have the eligible spend, then you don't have a claim.

One of the key expenditure categories for most companies claiming R&D tax relief is made up of 'Staffing costs' - here we look at some common pitfalls and potential traps for the unwary:

Staffing costs - how do you calculate them for R&D?

Having identified a qualifying R&D project, some founders (wrongly) attempt to calculate the eligible staffing cost by applying a 'bottom-up' approach.

So they look at the number of hours spent on a project (which is correct) but then then seek to apply a notional 'cost per hour' or 'day-rate'.

This approach is incorrect.

Instead, you need to take a 'top-down' approach.

This means that you should apportion the number of hours or days worked to the:

1. gross salary
2. employer's NIC and
3. employer's pension contributions (if any)

as posted to the company's accounts in that financial accounting period.

This approach should be applied on a line-by-line basis for each director or employee engaged in the R&D project work.

This difference in approach is often most painful for single-person companies where the founder is an 'inventor' or developer who has 'boot-strapped' the development i.e. paying themselves little or no salary.

Here (unfortunately), applying a 'notional market salary' is not allowed.

"If I had been paid a market rate salary I would have received £x!"

What counts are the costs that have been reported through PAYE (via RTI) and posted to the statutory accounts as salary in that period.

The fact that the founder might have invested 'blood, sweat and tears', unfortunately does not help for R&D tax purposes.

Accrued or unpaid salaries or bonus - impact on R&D tax claims?

In some cases, a business might accrue for salary or bonus amounts that it doesn't have the cash to pay or settle by the financial year end.

Is this cost allowable within an R&D tax credit claim?

The basic rule for corporation tax purposes is that so long as the accrued salary/bonus is paid within nine months of the accounting period end, then it is deductible in that accounting period end in which it was accrued.

The R&D tax rules follow this principle.

By way of example:

Say a company has a 31 December 2020 year end and it accrues a bonus of £20,000 for an employee (ie it is not paid, but owed at the year end), then it is deductible for tax purposes in the 2020 year end if it is paid by 30 September 2021.

So the R&D tax treatment follows: if paid by 30 Sept 2021, the bonus can be included in the R&D claim for the 31 Dec 2020 year end (subject to whatever % apportionment is applicable)

Do dividends count as a qualifying R&D cost?

No, dividends are not a qualifying cost for R&D tax purposes.

So director/shareholders might want to (re)consider their remuneration package to achieve the best overall result.

Do redundancy costs count as a qualifying R&D cost?

No, redundancy does not count as 'emoluments' so this cost is ineligible for R&D purposes.

This represents just a small snap-shot of some of the factors that we see regarding the eligibility of staffing costs and some of the pitfalls.