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This is part two of our four part guide for accountants that want to develop their knowledge, grow their practice and provide their clients with R&D tax relief services. Companies can also use this to prepare and submit their own R&D tax credit claims.
The other parts cover:
The definitions of research and development can be found within GAAP. According to FRS 102 they are as follows:
These definitions are probably what most people think when asked what is research and development. This is one of the reasons why many accountants do not identify qualifying R&D projects undertaken by their clients. Most of the work that our firm has got to date is the result of accountants failing to recognise R&D for tax purposes for their clients.
The definition of R&D has been modified by Guidelines on the meaning of Research and Development for Tax Purposes (issued by the Department for Business, Innovation and Skills). This is much more useful in helping accountants identify qualifying R&D. The definition is as follows:
The modified guidelines has a purposeful wide definition, enabling companies of all sizes and within all sectors to qualify for R&D tax relief. We will break down this definition to help accountants identify qualifying R&D activities.
“R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology.”
The advance in the definition is expansive and it includes the following:
The overall knowledge or capability is:
This could include undertaking new research into developing human tissue and replacing damaged tissue in the human body. It could also be developing new materials such graphene.
These types of projects are usually huge and have a lot of funding. The companies that undertake this sort of R&D will have financial backing and will normally be clients of larger accountancy firms.
Following the graphene example above, this could be creating new technologies based on the graphene such as LED, smart phone screen and solar cells.
An appreciable improvement is when a company changes or adapts the scientific or technological characteristics of something to make it better than the original. It could involve making an existing product smaller, cheaper, faster, stronger, efficient etc.
As an example, a paint manufacturer may develop a paint, similar to its existing products, but this dries faster or has better waterproof qualities. Or it could be new software that is faster and more efficient than its competitors.
For medium and small accountancy firms, the majority of qualifying R&D projects would most likely fall into this category.
The advance itself can be tangible or intangible. Examples of tangible advances include less waste production, creating faster drying paints, developing stronger and lighter materials. Intangible advances include creating new knowledge, reducing costs of production and faster production.
If an advance in science or technology has already been accomplished (or attempted to be) by another company and the details are not readily available as they are trade secrets, then a project to seek this advance can still qualify. This includes if a competitor is competing at the same cutting edge technology.
The definition includes “seeks to achieve”. This means that the project should attempt to achieve the advance and whether it achieves it or not is irrelevant from a tax point of view. Projects that have failed or are not yet complete therefore also qualify as an advance.
Projects that involve routine work do not meet the advance aspect of the definition, so would not qualify. Examples include developing basic WordPress websites, creating classic fire extinguishers and producing chemicals using typical formulations.
The definition of science is limited to the study of nature and behaviour of the physical and material universe. It excludes works of arts, humanities, social sciences, economics and mathematics (unless the math furthers science involved with nature and behaviour of the physical and material universe).
“The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D.”
Firstly we should clarify the difference between activities and projects. The project is the overall task of developing something, whereas the activities are the smaller parts of the projects, such as design, prototyping etc.
Although the project may meet the first part of the definition and qualify, costs only associated with qualifying activities within the project can be claimed. This means that not all activities within the project qualify. This is important when determining the staff time spent on a qualifying project. We shall cover this in the next blog.
So what is the “directly contribute” as per the definition? To directly contribute, activities must attempt to resolve part or parts of the scientific or technological uncertainty in connection with the advance.
These activities include :
It excludes activities such as:
The definition also looks at “uncertainty”. Scientific or technological uncertainty exists when:
Included in the definition of uncertainty is system uncertainty, which is a result of the complexity of a system rather than the uncertainty of how its individual components behave. The uncertainty could exist with the best way to combine these components to achieve an overall function or performance.
For example, in a remote control for a drone the characteristics of the components are known. The engineers know how each component works individually. The engineer however may not know if the components can be arranged in a different way to improve the speed of directing the drone, or by using different components they may be able to improve the distance the control can work.
Another example can be illustrated when developing software, where the developer knows the purpose of certain tools, but does not know how to combine the tools to make the whole system work more efficiently. This is usually the case for large software development projects.
It is inherent that uncertainty will exist when undertaking new scientific research or developing new or improved processes, materials, devices, products or services through new technology. So you should talk to your clients when this type of work has been undertaken and check if they can claim R&D tax credits.
Projects that can be easily resolved by a competent professional or work that involves minor changes, which do not affect the underlying science or technology would not meet the uncertainty aspect of the definition and would therefore not qualify for R&D tax relief.
“Certain qualifying indirect activities related to the project are also R&D. Activities other than qualifying indirect activities which do not directly contribute to the resolution of the project’s scientific or technological uncertainty are not R&D.”
These activities do not directly contribute to the resolution of scientific or technological uncertainties but do form part of the project. These activities are as follows:
We understand that the definition of R&D is complicated and long winded. We have simplified the R&D definition into the following three points:
The qualifying R&D activities start when work to resolve the scientific or technological uncertainty begins and the qualifying activities end when the uncertainty has been resolved or work to resolve it has ended.
To help you identify the more common qualifying R&D projects, these would normally include:
Once you have identified your clients qualifying R&D projects, you will need to ascertain the costs they can claim. We shall cover this in Part 3 – allowable costs for R&D tax credits.
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