The impact of VAT on R&D tax relief claims — good and bad

A great deal of the money businesses spend in pursuit of Research & Development (R&D) will incur VAT.

Though it’s not normally the case, accountants need to be alert to when VAT payments can be included in the qualifying costs of an R&D tax relief claim. This can have a significant impact on the tax benefit that affected companies ultimately receive.

In this article, we take a closer look at how a company’s VAT classification can impact its R&D claim.

The basic position

When making an R&D tax relief claim, the amount of tax relief a company is entitled to depends on two main factors. Firstly, how much of their outlay is incurred in carrying out eligible activities — known as ‘qualifying expenditure’. Secondly, their broader tax position.

Qualifying expenditure can only include revenue expenditure items, which means they are costs that are deductible for Corporation Tax purposes. These qualifying expenditures typically fall under one of the following categories:

– Staff costs and reimbursed expenditure

– Subcontractors & Externally Provided Workers (EPWs)

– Consumables

– Software

– Payments to Clinical Trial Volunteers

While staff costs do not generally attract VAT, the rest usually do. This is important for those companies that are VAT exempt, because they are not allowed to recover the VAT on their expenditure. These companies — unlike businesses that do charge VAT on goods and services and can claim back the VAT — may be able to include the VAT amounts paid out as part of their qualifying expenditure within an R&D tax relief claim.

This will only affect a minority of companies but, for those who are impacted, the increase in benefit can be significant. Examples of industries where businesses are more likely to be VAT exempt are:

• insurance firms

• finance and credit providers

• healthcare companies providing medical, optician and dental care

• companies providing education and training

• businesses involved in selling, leasing and letting commercial land and buildings

A further complication

The impact of VAT on an R&D claim doesn’t stop there. Any outstanding VAT liabilities owed to HMRC can also affect the cash repayment due following a successful claim. And while  VAT deferrals — typically as part of the Government’s COVID-19 package of support measures — aren’t classified as tax owed, Time To Pay (TTP) arrangements are considered to be tax owed and any R&D tax credit will be offset against the latter before being paid.

Staying on top of these rules will ensure a client does not risk over paying or under claiming.

Mehul Kyprianou‑Chavda is an R&D Tax Manager at business tax relief consultancy Catax. He can be contacted at mehul@catax.com.