R&D Tax Credit: Sub-Contractor

Subcontracted R&D activities are an often overlooked or misunderstood category of the R&D tax credit so we attempt to highlight and clarify some areas of confusion here.

The guidelines state that the outsourced activity must constitute qualifying R&D activity in its own right.  Therefore, if you send your design to have a mould cast or you subcontract the nutritional testing of your new recipe, neither activity will qualify as they are not R&D in their own right.  However, if you require a widget to make your new design function and the widget is not on the market or readily deducible to design and you ask a subcontracting party to design and develop this for you to meet your specification (BUT not to your specific design), that subcontracting party is undertaking R&D in its own right and the activity is therefore eligible.

This then throws in another area of confusion – who can claim? The guidelines state that the company claiming the credit for these costs, must notify the subcontracting party in writing that they may not make a claim for the R&D credit for these purposes.  So the onus is on the contracting company to stipulate this and perhaps it is worth contracting companies considering including this as a clause in their commercial negotiations.  But what if you are the subcontracting party and you haven’t received any such notification?  You must ask the contracting company and obtain something in writing stipulating that they are not claiming credit for this activity otherwise in an audit situation your claim would potentially be ineligible.

The final area of confusion concerns the different levels of expenditure that are claimable.  The guidelines do not clearly stipulate whether these limits are on project or total claim basis, however it is our current understanding that they are on a total claim.  Two positions are stated, both subject to the company incurring at least the same level of expenditure on qualifying activities:

• For a university or institute of higher education, relief is restricted to the greater of:
  • 5% of expenditure incurred or
  • Up to €100,000
• For another person (who is not a connected person) the relief is restricted to the greater of:
  • 15% of expenditure incurred or
  • Up to €100,000

These limits seriously constrict the amount of relief claimable under this category,

• For example, your company spends €200,000 qualifying expenditure and €250,000 for a subcontracting party on qualifying activities.
  • You are limited to the company incurring the same level of expenditure so first limit would be €200,000
  • For the subcontracted work you can claim the greater of 15% of your €200,000 i.e. €30,000 or €100,000 (maximum allowance).
  • So in this instance the eligible costs are €200,000 + €100,000 = €300,000.

Obviously this limits the eligible expenditure for this cost category, irrespective of what it costs the company, unless your company is spending in excess of €666,666 which we find only applies to the few!

Is there any way of maximising this? A possible nuance to consider for new multi-year projects during commercial negotiations would be staged payments.

• For example, your company spends €200,000 on qualifying expenditure each year and over the next three years will spend €250,000 with a subcontracting party on qualifying activities.
  • Based on example above, with the subcontracting party being paid on delivery
    • in year 1 eligible expenditure €200,000;
    • in year 2 eligible expenditure €200,000;
    • in year 3 eligible expenditure €200,000+€100,000.
    • Total eligible expenditure over three years €700,000
  • However, if during commercial negotiations a series of staged milestones were agreed against the developmental activities for the three years.
    • In year 1 against an R&D deliverable subcontracting party paid €100,000. Company meets criteria to have incurred same level of expenditure; 15% would be €15,000 but can claim the greater – therefore in year 1 eligible expenditure €200,000 + €100,000 = €300,000
    • In year 2 against an R&D deliverable subcontracting party paid €100,000. Company eligible expenditure €200,000 + €100,000 = €300,000
    • In year 3 against an R&D deliverable subcontracting party paid €50,000. Company eligible expenditure €200,000 + €50,000 = €250,000
    • Total eligible expenditure over three years €850,000.

So eligible expenditure increases by €150,000 in this example, so it’s worth considering.

For a detailed evaluation on subcontracting R&D activities, please contact the professionals at Braithwaite:

Victoria Procunier
Senior Business Consultant
Mobile: +353 85 216 6966
Email: vprocunier@braithwaite.ie