Many company owners often assume that the cost of their time can be used to reduce their tax burden in the same way as their salaried employees’ time and energy but it’s not necessarily so.
Here we will explore the rationale behind two company outgoings which, confusingly, are not included in qualifying costs when making R&D tax relief claims – dividends and expenses paid directly by the company.
Salaries are generally less tax-efficient than dividends, which enjoy a lower income tax rate and also aren’t subject to National Insurance.
So being paid in dividends might appear to be the most tax-efficient option but there are implications when it comes to R&D tax relief claims.
Dividends cannot be factored into an R&D claim because they are technically not a reward for services — meaning they cannot be linked with R&D time and effort. They are therefore not deemed to be a tax-deductible cost.
This is because dividends are a return on profit paid to shareholders, not remuneration for services provided. That’s why dividends must be paid in line with shareholdings though so-called alphabet shares are often used as a way around this issue, allowing dividends to be paid at different rates per share for specific shareholders.
So should a company carrying out R&D work pay salaries or dividends to those shareholders carrying out this vital work? Shareholders spending substantial amounts of time on R&D projects may want to consider switching to payment entirely in salary as the extra Corporation Tax relief generated through R&D will outweigh the National Insurance cost at a certain tipping point.
There may be other good reasons not to change the remuneration policy, so always seek thorough advice on the best structure to use.
Another source of frustration to many claimants lies in the fact that reimbursed expenses that relate to R&D, like travel and accommodation, can be allowed as a qualifying cost, yet costs incurred directly by the company cannot.
The HMRC legislation defines staff costs as including “an amount paid to a director or an employee of the company, other than an amount paid in respect of benefits in kind, if the amount is paid in respect of expenses paid by the director or employee, and the amount is paid because of the director’s or employee’s employment”.
This definition of staff costs does still include gross pay, employer National Insurance and employer pension. But because of the HMRC definition, additional staff costs only extend to work-related expenses that directors and employees pay out of their own pocket first before being reimbursed.
Some companies may consider changing their expense policy to have staff pay for relevant costs personally and then claim them back. However, for smaller amounts the extra costs of administration could outweigh the additional tax relief.
This is a simplification of two complex situations, and advice should be sought before altering pay and expense policies.
As with many things related to tax, it is easy to get R&D tax relief claims wrong. The best-case scenario when submitting R&D claims with costs that do not qualify is that the claim is rejected, wasting many hours of work. The worst-case scenario is that the company may be penalised, with fines running into tens of thousands of pounds.
Protect yourself against this by ensuring you seek expert advice on how to optimise your R&D and other tax relief claims.
Nigel Holmes, head of R&D Technical Operations at specialist tax consultancy Catax