Which Costs Qualify for R&D Tax Relief?
Qualifying R&D costs fall into seven categories: staff costs, externally provided workers, contracted-out R&D, consumable items, software, cloud computing and data licences, and payments to clinical trial volunteers. Each must relate directly to qualifying R&D, and since April 2024 contractor and agency costs generally need to relate to UK work.
What staff costs qualify?
Staff costs include salaries, wages, overtime, bonuses, employer National Insurance and employer pension contributions for employees directly and actively engaged in R&D, including people who directly support it. Benefits in kind, such as company cars, do not qualify. Most claims apportion each person's costs by the share of time spent on qualifying work, so good time records matter.
What are externally provided workers?
Externally provided workers (EPWs) are individuals supplied by a staff provider, such as an agency, who work under your supervision, direction or control. Under the merged scheme, unconnected EPW costs usually qualify at 65%. From April 2024 the worker generally needs to be subject to UK PAYE for the costs to qualify, with limited exceptions.
How does contracted-out R&D work?
Under the merged scheme, the company that decides to undertake the R&D can generally claim for work it contracts out, with unconnected contractor payments usually qualifying at 65%. If the R&D was intended or contemplated by a customer when the contract was made, the customer is generally the one that claims. From April 2024 the contracted-out work generally has to be done in the UK, unless conditions such as geography, environment, population or legal or regulatory requirements make UK work impossible. Cost and staff availability are not enough.
Which consumables qualify?
Consumables are materials and items used up or transformed in the R&D, plus water, fuel and power used in it. Items that become part of a product you sell, or prototypes that are later sold, do not qualify.
Do software, cloud and data costs qualify?
Yes. Software used directly in R&D qualifies, apportioned where it is also used for other work. Since April 2023, cloud computing services (such as compute, storage and associated software) and data licences used directly for R&D also qualify. Cloud costs for live production systems do not.
What about clinical trial volunteers?
Payments to volunteers taking part in clinical trials qualify as a separate category.
What costs never qualify?
- Capital expenditure, such as equipment and buildings (R&D allowances may help instead)
- Rent, rates and general overheads
- Patent and legal costs
- Benefits in kind and recruitment fees
- Production costs and items sold
Summary table
| Category | Share that qualifies | UK rule from April 2024 |
|---|---|---|
| Staff costs | R&D share of eligible pay costs | Not restricted |
| Externally provided workers | Usually 65% if unconnected | Generally must be subject to UK PAYE |
| Contracted-out R&D | Usually 65% if unconnected | Generally must be UK work |
| Consumables | Amount used in R&D | Not restricted |
| Software, cloud and data | R&D share | Not restricted |
| Clinical trial volunteers | Payments made | Not restricted |
Connected party rules can change the 65% figure. A specialist should review each contractor and agency arrangement.
Sources
How should staff time be apportioned?
Staff time should be apportioned using a method you can explain and evidence. The best evidence is a time record made during the year, such as timesheets or project codes in your task tracker. Where that does not exist, a reasoned estimate by the technical lead, based on project plans and who worked on what, can be acceptable if it is recorded and realistic. Avoid round numbers applied to everyone, such as claiming 80% of every engineer's time, unless the evidence supports it.
Example: a developer earning £60,000 with £7,500 employer NIC and £3,000 employer pension spends 40% of their time on qualifying work. The qualifying staff cost is 40% of £70,500, which is £28,200.
Which staff can be included?
- Engineers, developers, scientists and technicians working directly on the R&D
- Technical managers directing the R&D, for the time spent doing so
- Directors paid through PAYE, for the time they spend on the R&D
- Support staff for qualifying indirect activities, such as technical librarians or maintenance of R&D equipment
Sales, marketing, general finance and HR staff are normally excluded, as is time spent on routine work by technical staff.
What are connected parties, and why do they matter?
Connected parties are companies under common control, such as group companies. When R&D is contracted out to, or workers are supplied by, a connected party, the qualifying amount is usually based on the connected party's own relevant costs rather than the price charged, subject to rules. Connected party costs also affect the PAYE cap exemption. A specialist should map group relationships before building the claim.
How are software costs apportioned?
Software used only for R&D qualifies in full. Software used for both R&D and other work, such as a development tool used for both new projects and maintenance, must be apportioned on a reasonable basis, often the same share as the staff time of the people using it. General office software and accounting packages do not qualify.
What counts as cloud computing?
For periods beginning from 1 April 2023, cloud computing costs that qualify include computing power, data storage and software provided through the cloud, where they are directly used in R&D. This covers development and test environments and compute used for experiments and model training. Live hosting for customers is a commercial cost and does not qualify. Tagging cloud resources by project or environment makes apportionment much easier.
What counts as a data licence?
Qualifying data licence costs are payments for licences to use data in R&D, such as datasets bought to train or test a model. Data you collect yourself is not a licence cost, although the staff time spent collecting it may qualify if it is part of the R&D.
How are prototypes treated?
The materials consumed in building and testing a prototype can qualify as consumables. If a prototype or the output of a trial is later sold, or becomes part of a product sold to a customer, those materials generally do not qualify. Capital equipment used in R&D, such as a test rig built to last, is outside R&D tax relief but may qualify for capital allowances.
How are grant funded costs handled?
For accounting periods from April 2024, grant funded costs are no longer pushed into a less generous scheme. The costs still need to be identified, and some grants require you to declare them or limit what you can claim. Keep grant agreements and project budgets with your R&D records.
A worked example claim
| Cost | Total cost | Qualifying share | Qualifying amount |
|---|---|---|---|
| Engineering staff costs | £400,000 | 45% | £180,000 |
| UK agency developer (EPW, unconnected) | £50,000 | 65% of 80% R&D time | £26,000 |
| Cloud development and test environments | £30,000 | 70% | £21,000 |
| Development software | £10,000 | 45% | £4,500 |
| Total | £231,500 |
Illustrative only. At 25% tax, a merged scheme credit on £231,500 would be worth about £34,725 after tax.
Checklist before you claim
- Payroll reports for the period, with employer NIC and pension
- Time records or an agreed apportionment method
- Contractor and agency invoices, contracts and where the work was done
- Software, cloud and data licence invoices with usage notes
- Materials and utilities used in trials
- Group structure and any connected party arrangements
- Grant agreements
Externally provided worker or subcontractor: how to tell
| Feature | Externally provided worker | Contracted-out R&D |
|---|---|---|
| Who directs the work | Your company supervises and directs the individual | The contractor decides how to deliver the work |
| How it is bought | Through a staff provider, such as an agency | A contract to deliver a piece of R&D |
| Usual qualifying share if unconnected | 65% | 65% |
| UK rule from April 2024 | Generally must be subject to UK PAYE and NIC | Generally must be work done in the UK |
Getting the category right matters because the evidence and rules differ. Freelancers contracted directly, rather than through an agency, are usually treated as contracted-out R&D.
Do bonuses and pension contributions count?
Yes. Bonuses paid through payroll, employer NIC and employer pension contributions count as staff costs and are apportioned in the same way as salary. Benefits in kind, such as company cars and private medical cover, do not count.
Capital or revenue?
R&D tax relief applies to revenue expenditure. Spending on assets that last beyond the project, such as test rigs, laboratory equipment and buildings, is capital. Capital spent on R&D may qualify for R&D allowances or other capital allowances instead. If something is built as part of the experiment and then scrapped, it may be a consumable rather than a capital asset. Treat borderline items consistently with your accounts.
Can overheads be included?
No. Rent, rates, insurance and general overheads are not qualifying costs, even where they support R&D. Utilities only qualify where they are consumed directly in the R&D, such as power used by test equipment.
What do HMRC officers check in cost schedules?
- Whether staff costs reconcile to payroll records and the accounts
- Whether apportionment percentages are supported by records or reasoning
- Whether contractors and agencies are categorised correctly, and where the work was done
- Whether consumables were used up in R&D and not sold
- Whether cloud and software costs were apportioned between R&D and other use
How can you make next year's claim easier?
Set up simple habits now: tag R&D tickets or project codes, keep a short monthly note per project, separate development and live cloud environments, and store contractor contracts with where the work was done. These steps take minutes a month and can save days at year end, as well as making the claim much easier to defend.
Ready to check your figures? Try our calculator, then ask a specialist to review the detail.
Which costs matter most in each sector?
| Sector | Largest cost | Often overlooked |
|---|---|---|
| Software and AI | Developer staff costs | Cloud costs for development and testing, data licences |
| Manufacturing | Engineers' staff costs | Production staff time on trials, scrapped trial materials |
| Life sciences | Scientists' staff costs | Clinical trial volunteer payments, bioinformatics software |
| Construction | Design engineers' time | Test and monitoring costs |
| Food and drink | Technologists' time | Ingredients and utilities used in pilot runs |
| Cleantech | Engineers' staff costs | Prototype components, simulation compute |
See our sector guides for examples of qualifying projects in each field.
Frequently asked questions
Do directors' salaries qualify?
Yes, for the time a director spends directly on R&D, if paid through PAYE. Dividends do not count.
Can we include freelancers?
Freelancers engaged directly are usually treated as contracted-out R&D, not staff or EPWs, and from April 2024 generally need to be doing UK work.
Do prototypes qualify?
The materials consumed in building and testing prototypes can qualify, unless the prototype is later sold.
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