Contractors' Questions: Should I mark invoices with 'R&D' for tax relief?

Contractor’s Question: I’ve been submitting invoices to a client for a year. He now wants me to edit the invoices to have itemised on them "R&D" because R&D work enables him to get tax relief. I’m happy to do this (I do software development work, and some of that is inherently research into how to get things to work), but will this have any kickback on me?

HM Revenue & Customs won’t be after me asking me to prove this is R&D work will they? I’m reluctant to start marking my invoices as R&D until I’m sure there will be no comeback on me. Why doesn’t everyone just ask for invoices to have "R&D" on it if there is some tax incentive?! Some guidance from an independent and reputable accountant would be ideal.

Expert’s Answer: Special tax reliefs for expenditure incurred by companies on Research and Development (as defined) have been available since 2000. Relief is given by enhancing the corporation tax deduction on qualifying costs.

For SMEs the enhancement is 125%, so £100 of expenditure creates a tax deduction of £225 – an additional tax ‘subsidy’ of £25. In the case of contracted out R&D where the client and the contractor are unconnected, 65% of the costs will qualify.

There is clearly an incentive, therefore, for companies to identify as much expenditure as possible as qualifying for the relief, and this is almost certainly behind your client’s request. However, simply describing your work as ‘R&D’ in your invoices does not of itself bring the expenditure into the ‘qualifying’ category. Your client will have to meet a range of conditions to support his claim.

You mention that your activity involves software development work. Briefly, it is HMRC's position that the creation of software can be R&D but the basic conditions for all R&D claims must be met – the project must lead to a scientific or technological advance, and/or the resolution of an uncertainty.

Helpfully, HMRC have provided in their guidance a number of examples of software projects which are, as the case may be, either likely or unlikely to qualify as R&D in their own right. You can access the guidance in this HMRC manual.

Responsibility for establishing whether the work you do for your client satisfies the requirements for relief rests squarely with your client. Knowingly making a claim for expenditure that patently does not qualify is fraud, and could well result in a criminal prosecution. Your client would be well advised to seek expert advice in this complex area before including the claim in his corporation tax returns, regardless of the narrative in your invoices.

The expert was Graham Morgan, a corporate tax partner at top 20 chartered accountancy firm Kingston Smith LLP.