Eligible Costs for R&D Tax Relief

The list of costs that qualify for R&D tax relief is exhaustive, not illustrative. HMRC defines nine specific categories, and anything outside them cannot be included in a claim. Understanding exactly what falls inside each category (and where the limits are) is one of the most material decisions you will make when preparing your claim.

This article sets out each cost category, how apportionment works, and the costs that commonly appear in claims but should not.

The qualifying cost categories

Under the current Merged Scheme, all companies can claim for the following:

• Staff costs
• Subcontracted R&D costs
• Externally provided workers (EPWs)
• Contributions to independent R&D (in some cases)
• Software licences
• Data licences
• Cloud computing costs
• Consumable items
• Payments to clinical trial volunteers

Each category comes with its own rules. The sections below cover the details that most often affect the value of a claim.

Staff costs

Staff expenditure is typically the largest category in any R&D claim. The scope is broader than many companies expect: it is not limited to dedicated R&D roles. Engineers, developers, and scientists are the obvious inclusions, but supervisors, project managers, and senior management involved in qualifying activities can also be counted. Even staff performing indirect supporting activities, such as HR recruitment or project costing for the R&D programme, may qualify.

There is no requirement for R&D job titles or a formal R&D team structure. What matters is the activity, not the department.

The specific costs that can be claimed are:

• Salaries and wages
• Bonuses
• Employer pension contributions
• Secondary Class 1 National Insurance contributions paid by the company
• Reimbursed expenses incurred by the employee in carrying out R&D (where the employee pays first and claims back)

Worth noting: if a staff member uses a company credit card, those expenses cannot be included. Only costs that flow through the employee's personal expense claim are eligible.

Directors and dividends

Many founders and directors in early-stage companies draw dividends rather than salaries. Dividend payments are not eligible for R&D tax relief. Where a director is genuinely involved in qualifying R&D, it may be worth considering whether a salary arrangement is more advantageous for the company overall; however, this requires care and should be evaluated case by case.

Subcontractors and externally provided workers

These two categories are often confused, and the distinction matters.

Subcontractors are third-party companies contracted to carry out R&D activity. Under the Merged Scheme (accounting periods beginning on or after 1 April 2024), all companies can now claim for subcontracted costs. This was a significant change: under the old RDEC scheme, large companies could not include subcontractor costs at all.

Externally provided workers (EPWs) are individuals supplied by a staff agency who work under the claimant company's supervision, direction, or control. The key difference from subcontractors is that EPWs are effectively augmenting the company's workforce rather than operating independently.

Connected versus unconnected

For unconnected contractors and EPWs, only 65% of the relevant R&D costs can be claimed. The reduction accounts for the contractor's profit margin. If an invoice is half R&D and half non-R&D, 32.5% of the total (65% of the 50% that qualifies) can be included.

For connected parties, the 65% cap does not apply; instead, the claim is limited to the actual cost incurred by the contractor, without markup. A look-through test is required to confirm what was genuinely spent on R&D. Note that any payments to a contractor who is also a director of the claimant company cannot be included at all.

Who has the right to claim under the Merged Scheme?

Under the Merged Scheme, the right to claim follows the company that "intended or contemplated" the R&D before it began. In practice, this means the contracting party should document its expectation that R&D will be carried out, specifying what advance or uncertainty is being addressed. High-level contract wording alone is not sufficient; surrounding circumstances, IP ownership, and financial risk will all be considered.

Where the contracting party genuinely had no expectation of R&D, the contractor may be entitled to claim. The full detail of these rules is covered in our article on subcontracted R&D.

The overseas restriction on outsourced R&D

From 1 April 2024, subcontracted costs and EPW costs can only be claimed where the work is physically carried out in the UK. Nationality is irrelevant; it is where the R&D happens that determines eligibility. If a contractor performs work partly in the UK and partly abroad, the costs must be apportioned on a just and reasonable basis.

There are narrow exceptions. Overseas costs can still be claimed where the conditions necessary for the R&D are not available in the UK and cannot reasonably be replicated here. Examples include research on a disease not present in the UK, access to specialist equipment unavailable domestically, or geophysical conditions that cannot be replicated. Lower cost or easier access to overseas workers are not valid reasons on their own.

See our guide for all the details: Understanding the New Overseas Rules for R&D Tax Credits in the UK

Software licences

Software costs can be claimed where the software is directly used in qualifying R&D activity, or in qualifying indirect activities that support R&D. Where software is used partly for R&D and partly for other purposes, an appropriate apportionment is required. A common approach is to base the apportionment on the ratio of R&D user licences to non-R&D licences, or on the ratio of R&D staff time to total staff time.

Data licences and cloud computing

For accounting periods beginning on or after 1 April 2023, data licences and cloud computing costs became claimable. A data licence covers access to and use of a collection of digital data. Cloud computing encompasses data storage, hardware facilities, operating systems, and software platforms. The same apportionment principles apply: only the proportion attributable to resolving the scientific or technological uncertainty can be included.

Consumable items

Materials, components, and the proportion of water, fuel, and power consumed directly in qualifying R&D activity are all eligible. For manufacturing and engineering projects, this typically includes materials used to build prototypes and components destroyed or transformed in testing.

One limit worth noting: if materials are incorporated into a product that is subsequently sold, those material costs cannot be claimed. Claiming them would mean benefiting from the cost twice, once through the tax relief and once through the sale. The costs of a prototype that goes on to be sold commercially are not eligible on this basis.

Payments to clinical trial volunteers

Where R&D involves clinical trials, payments made directly to trial participants form their own category. HMRC expects R&D involvement across the drug discovery phase, preclinical development, and phases I through III of trials (phase IV is less likely to qualify). This category is not subject to the overseas restriction, so volunteer payments made in connection with overseas trials can still be included, even where staff costs for administering those trials may not.

Costs that can never be claimed

Several cost types appear regularly in R&D but fall outside the eligible categories. Including them is likely to prompt a compliance check. The following cannot be claimed:

• Rent and premises costs
• Capital expenditure (equipment, machinery)
• Patent costs
• Director dividend payments
• Training provider fees and the Apprenticeship Levy
• Materials incorporated into products that are later sold

Apportioning costs

Most companies do not spend 100% of their resources on R&D. Where a cost is only partly attributable to qualifying activity, a reasonable apportionment must be made and documented.

For staff, HMRC expects time records. Timesheets are the most straightforward approach; estimates are acceptable where they have a genuine evidentiary basis, such as a project plan or management assessment. A rule of thumb: claiming more than 95% of any individual's time for R&D is difficult to justify in practice, even for dedicated R&D staff. The proportion for management and executive roles is typically lower still.

For other cost categories, the staff apportionment ratio is often used as a proxy. If 40% of total staff costs relate to R&D, it may be reasonable to apply the same proportion to software licences or consumables, provided this reflects the actual pattern of use.

Key takeaways

• The list of qualifying cost categories is exhaustive. Costs outside the eight categories cannot be included, regardless of how directly they relate to the R&D project.
• Staff costs can include a wide range of roles, but only costs processed through payroll are eligible. Dividends are not.
• Subcontractor and EPW costs are capped at 65% for unconnected parties; connected party costs are claimable at actual cost.
• The overseas restriction applies to subcontractors and EPWs from 1 April 2024. Only UK-performed R&D qualifies, with narrow exceptions.
• Clinical trial volunteer payments are exempt from the overseas restriction and can be claimed even where the trial takes place abroad.
• Apportionment is required wherever a cost is only partially R&D. Timesheets are the most defensible record for staff time.

Getting the cost calculation right has a direct impact on the value of a claim, and errors in this area are one of the most common triggers for HMRC compliance checks. If you are preparing a claim under the Merged Scheme for the first time, or if your R&D involves subcontracted work, overseas workers, or a complex cost base, specialist input is worth considering before you file. Contact Myriad to discuss your specific situation.