TQOTW: Subcontracted R&D and subsidies
My client is an SME but has received a grant in relation to the labour costs involved in the project. We have allocated this to cover some of our subcontractor costs from an unconnected third party and so can we just claim 65% of this or is it blocked because its subsidised?

The SME R&D Expenditure scheme

Where a SME is looking to obtain tax relief for qualifying R&D expenditure this is usually obtained by obtaining an additional tax deduction for these expenses. This, in effect, increases the expenses to reduce income charged to corporation tax. If expenses exceed the profits generated the surrenderable amount can be surrendered for a 14.5% payable R&D tax credit.

SME and subsidised expenditure

However, the expense in relation to contracted out R&D, needs to meet all the conditions listed in CTA 2009 s1053. As you indicate that you have allocated this grant to subcontractor costs, we will fail condition D ‘expenditure is not subsidised’ and so the expenditure cannot fall under the SME R&D scheme.

Subsidies and ‘just and reasonable’ apportionment

You do mention in your query that the grant has been received to cover labour costs and that ‘some’ will be used for the subcontractor costs. CTA 2009 s1138 clarifies what the meaning of ‘subsidised expenditure’ is in relation to this part of the legislation. CTA 2009 s1138 (4) states that where grant is not allocated to a particular expenditure that it can, for these purposes, be allocated on a just and reasonable basis. As such it may be worth reviewing the grant application to ascertain what part is subsidised, as the remainder, if all conditions of s1053 are met, could be claimed under the SME R&D scheme.

SME subsidised expenditure and RDEC

It seems likely some, if not all, of the subcontractor cost will fall out of the SME scheme, but there might still be scope to obtain some relief under the RDEC scheme.

The RDEC scheme is used by large companies who do not meet the meaning of SME in CTA 2009 s1119 for qualifying R&D projects. Instead of increasing the expenditure allowed as a tax deduction RDEC allows a 14.5% credit on expenses that qualify for R&D.

But the RDEC is not just restricted to large companies the legislation does give some scope for SME to claim expenditure that drops out of the SME scheme due to this being subsidised under CTA 2009 s104A(3). This may be worth some further investigation as this will allow a 14.5% credit for this subcontractor expenditure if it meets the conditions.

However, the conditions, in this case, are narrower and all the conditions of s104H must be met. The narrow condition relates to the subcontractor themselves. Condition B of s104H (3) states the subcontractor can only qualify under this section if they are:

  • A qualifying body (defined in s1142 generally charities, institute of higher education etc)
  • An individual. Or
  • A firm, each member of which is an individual

As such some SMEs fail to meet this as the subcontractor is a small limited co not caught by the qualifying body conditions and so there is no scope for R&D relief in either the SME R&D expenditure or RDEC scheme.


The subcontractor costs, if partly covered by a grant, can be allocated on a just and reasonable basis so that the unsubsidised part can be claimed as a tax deduction under the SME R&D expenditure scheme.

If the subsidised subcontractor costs meet all the conditions of CTA 2009 s104H then the expenditure will be eligible for a 14.5% payable tax credit under the RDEC scheme.

We recommend you review all the legislation provided, grant funding agreements and details of the subcontractor who has been contracted to ascertain if relief is available. Further guidance on this point can be found in HMRC Corporate Intangibles Research and Development manual CIRD89760.

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Tax Adviser
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Suzanne has been working in small practices since 2003 where she has gained a wealth of tax experience relating to smaller, owner managed businesses, buy to let landlords and individuals. Previously working in a small team, Suzanne has developed a good knowledge of all aspects of general tax, in particular income tax, VAT, corporate tax and PAYE.

Suzanne is a member of the Association of Accounting Technicians and Association of Chartered Certified Accountants.

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