The impact of ‘Connected Party’ relationships for R&D Tax Relief

When claiming R&D qualifying expenditure in respect of subcontractors and externally provided workers (EPW’s), special rules apply where there is a connection between the R&D claimant company and the subcontractor or the EPW provider.

There are several ways in which connection may occur; some may be through family relationships, others through common ownership and control. Innovation Tax are experts in complex areas of R&D legislation and can examine relationships which might have an impact on your claim.

Where a connection is identified, the ‘65%’ adjustment to qualifying expenditure on subcontractors and EPW’s no longer applies and we instead consider the ‘relevant expenditure’ incurred by the connected subcontractor or the EPW provider. Once the ‘relevant expenditure’ has been calculated, the value is compared to the payment made as part of a statutory connected parties test.

Whilst the ‘relevant expenditure’ calculation can include most of the cost headings we are familiar with for calculating R&D expenditure, one problematic area arises where a connected subcontractor further subcontracts compliant work out to an unconnected third party.

  • From HMRC’s perspective, this work should have been directly subcontracted out by the claimant company without a connected intermediary involved.
  • From a commercial perspective, in groups of companies, one company might have an existing commercial arrangement with the subcontractor and therefore be able to engage on better commercial terms then the claimant company.

As popular and logical as it may be, this commercial arrangement will cause the subcontracted R&D costs to fall outside of the costs allowable in a R&D claim.

As described above, where there is a corporate group structure and qualifying activity being undertaken by differing companies within a group, calculating the qualifying expenditure can become complicated and, in some cases, the expenditure may fall out of scope altogether due to the connected party legislation.

It’s worth noting that the claimant company and subcontractor / EPW provider can elect to be connected; this joint election is irrevocable but, in cases where there is a high level of transparency between the two parties, can help maximise the claim benefit by allowing the removal of the 65% restriction. A thorough understanding of the ‘relevant expenditure’ and connected party rules are required in order to fully understand the advantages and disadvantages of making such an election.

Contact Innovation Tax today for a no obligation review. We are specialists in claiming R&D Tax Credits, with vast experience dealing with the complex areas of the legislation.

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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