Differentiating between Subcontractors & EPW’s for R&D Tax Relief

We often come across situations where there is R&D being performed by persons other than those employed by the claimant company conducting qualifying activity.

The reasons for this are varied; however, these are some of the most common scenarios:

  • the claimant company does not have the specialist equipment or expertise required to conduct some of the work for the R&D project, therefore this element is subcontracted to a specialist in the sector.
  • the claimant company is short on resource within its own pool of staff and therefore has to decide whether to either employ additional members of staff – which is both a long-term commitment and a lengthy process in terms of getting both budgetary approval and the right candidate – or acquire a short term / fixed contract employee through an agency (staff provider). The latter is a popular option, as there is often a lack of visibility on the long-term resourcing requirements of an R&D project and agency staff provide a flexible stop gap solution.

When we talk to clients about their R&D projects, they often refer to ‘external consultants’ and so it’s important to carefully evaluate the nature of the activity being performed by these individuals (or entities) to ensure the costs are correctly recognised in the claim.

A typical subcontractor relationship for R&D

  • A subcontractor would typically work under their own steam and without supervision; as an expert within their field, they would be best placed to decide upon how to execute the task at hand without the assistance of the claimant company.
  • They are given a distinct task or sub-project within the R&D activity
  • They would not necessarily work from the claimant companies’ premises or have fixed hours of work. They have the autonomy to decide when and where they work subject to meeting deadlines and other reasonable constraints.
  • They can use a substitute to perform the work, and so the task subcontracted out need not be performed by a named individual within the subcontractor enterprise.
  • They would typically use their own equipment and would be expected to have their own pool of clients and thus free to perform work for others i.e. they do not work exclusively for the claimant company
  • They would be paid for performing their task within the wider R&D project, regardless of the outcome of the project overall.

A typical EPW (Externally Provided Worker) relationship for R&D

  • A named individual is brought into the claimant company as an additional resource. However, they are not on the payroll and the claimant company makes payment to a staff provider (Agency or similar) for the provision of the worker.
  • The named individual typically works from the claimant company’s premises, using the claimant company’s tools and equipment.
  • The staff provider is paid by the claimant company for the provision of the worker, usually on a time basis, and then pays the worker directly.

Over the years during which the R&D scheme has operated, the distinction between the two cost categories has become more of an issue. Where companies invest money into R&D projects, they inevitably grow and many are bought by large corporations and, in these situations, the company might move from being an SME (where they can claim for both EPW’s and Subcontractors) to being a ‘Large’ company, thus falling under the remit of the RDEC scheme. In this instance, only certain subcontractor costs qualify and hence the clarification between Subcontractor and EPW is vital.

Although the distinction is more important, certain elements of the legislation have been relaxed; for expenditure incurred on or after 1 April 2012, the complex tripartite restriction for expenditure on EPW’s was removed, simplifying matters for companies spending money on Agency staff.

As we have experienced in other areas of expenditure, there can be circumstances where genuine expenditure on external resource for R&D projects may not qualify for relief. One example is where a consultant is taken on a short-term contract and where;

  • the essence of the arrangement is that the named individual is a member of the team with the only distinction being that he/she is not on the payroll and invoices directly as a consultant without an umbrella company.
  • the individual works under the direction of the claimant company and is expected to work at the company premises using the company equipment.

If we consider the typical factors listed previously, the individual does not meet the definition of a subcontractor; the arrangement fits more closely with that of an EPW. However, in the absence of an agency/staff provider, the entire cost is ineligible for R&D relief.

At Innovation Tax, we have a wealth of experience and qualified staff to evaluate complex situations in relation to R&D costs. In the above situation, we would typically request sample invoices from the contractor, the amount paid to them in the claim period and a summary of the work / activity undertaken in order to form an opinion.

Also note that, once any costs relating to R&D qualifying activities for Subcontractors or EPW’s have been identified, there is a statutory reduction to these costs of 35%, i.e. only 65% of the qualifying costs can be included in the R&D claim.

Other complexities within this area are where there is a connection between the Subcontractor / EPW and the claimant R&D company, whereby the ‘65% rule’ does not come into play and is instead replaced with a Connected Parties test, which will be covered in more detail in another blog post.

Please see our separate blog post: Learn More About The Research and Development Expenditure Credit scheme for further information on how subcontractors can be included in a RDEC claim.

Innovation Tax specialise in helping companies access vital funding and tax incentives to enable their businesses to grow, increase profitability, reduce risk and enable further investment in R&D and capital investments.

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