For a project to be qualifying for Research and Development (R&D) tax purposes, this must involve an attempt to form an advance within a field of science or technology as a whole, involving the resolution of scientific or technological uncertainties and specific project boundaries.
For example, drug development and other life science projects usually quite neatly fits this criterion, as it is often clear how a project is seeking to improve upon existing scientific understanding or capabilities. In addition, there is a clear economic incentive for researchers to develop drugs and other compounds that provides tangible benefits and other advancements not previously achieved within the space.
Whilst it may seem like the entirety of a project will fit this definition it is important to note the differences between R&D within a commercial context, and qualifying R&D projects for tax purposes. This is because not all activities will qualify and so not all related costs can be claimed. Careful consideration is therefore essential in establishing the boundaries of an R&D project for a R&D tax relief claim.
Whilst projects can vary considerably in scope and their development within this field, we have prepared the below example to indicate a drug development project over a condensed period of four years, with typical examples of what project activities can and cannot qualify across each stage of this process.
Year one – drug discovery
This consists of target and lead compound identification, as well as drug synthesis, testing and toxicology research.
This is generally expected to be a very R&D intensive stage of the development process, and most of the direct compound development carried out by the research team would be expected to qualify. This is because it is this project work that will form the basis for the scientific advancement as whole. In addition, any supporting activities that are directly related to the project, including staff training, data collection, and maintaining equipment will also qualify. This may also include additional administration, finance and personnel activities where this is carried out in support of achieving the main R&D undertaken.
Any work involving support activities not related to the project, such as cleaning, repair, maintenance, and security activities would not be expected to qualify. In addition, any work to prepare grant applications across the entire life cycle of the project will not qualify for R&D tax relief.
Year two – preclinical development
Once candidate lead compounds have been established, further laboratory tests in vitro and on live animal testing takes place.
This stage is also considered to be fairly R&D intensive, and almost all of the laboratory testing would again be expected to qualify. This is because whilst the compounds themselves may not be modified directly over this period, the advance is still being sought through validating the drug discovery research and through seeking to further understand its properties and effects.
Any work to develop new testing and sampling methodologies for use in these trials will likely qualify, though as with the drug discovery stage any non-scientific supporting activities related to the transportation and storage of laboratory consumables and animals required for the tests would not qualify.
Year three – clinical development
Once a compound is identified from laboratory research that shows a potential therapeutical benefit, extensive human trialling is then conducted after which the drug licensing stage takes place.
This phase of the research largely involves validating the drug as a treatment, in which almost all of the testing work would likely consist of qualifying R&D. Any research into establishing common adverse effects and the dose response effect is likely to form part of the overall scientific advance. Additionally, any comparative efficacy and tolerability studies are also likely to qualify.
At this stage some early steps are usually taken to begin marketing the compound, and to assess the commercial value and viability of the drug as a treatment, which would fall outside the scope of a qualifying R&D project for tax purposes. Any work involving licensing the drug for commercial use, that does not involve further developing or testing the compound is also unlikely to qualify.
Year four – post launch
After a drug is licensed, any confirmatory, longer-term efficacy or further comparative studies then take place, alongside marketing and other commercial steps required to bring the compound to launch.
The majority of this project work would likely to be considered non-qualifying R&D, as by this stage the scientific advance would likely be achieved and validated, with the scientific uncertainties resolved. Despite this if there are any unusual circumstances that occur meaning that some further development work is required, some of the work during this stage could qualify.
This could consist of any further testing or evaluation work into previously unknown adverse effects of the drug, perhaps through its interaction with other medicines, or any assessments into improving its delivery methods.
Whilst the length of each of these stages and the specific research and testing will vary considerably depending on the nature of the project, this highlights the need for careful assessments to be made into the project activities to ensure that the correct descriptions of qualifying work undertaken is included within the report, and that only costs relating to qualifying activities are claimed.
Additionally, over the course of a project it is very important to document and keep details of the work undertaken throughout each period as this makes working with R&D tax advisors and drafting project narratives much easier. You should ensure that all project activities and phases over the course of the accounting periods are recorded and updated in detail to ensure that the report is fully reflective of the work undertaken for the accounting periods. This is very important to demonstrate the project’s progression to HMRC and to justify all costs claimed.
Costs associated with a qualifying drug development project
In calculating project costs in preparing an R&D tax relief claim, it is important to be mindful that not all associated project costs can qualify. Specifically, qualifying project spend will need to consist of expenditure for one of the following categories:
- Staffing costs
- Consumables costs (including water, fuel, and power)
- Subcontractor costs
- Externally provided worker costs
- Software costs
- Data licence and cloud computing costs
- Payments to clinical trial participants
All costs will need to be deductible for tax purposes and so cannot be capital in nature. Whilst the costs claimed will depend on the specific project work, for drug development projects higher proportions of staffing, consumables, and subcontractor costs are common. In addition, payments to clinical trial participants can be claimed once this stage of the development process is reached.
The below example provides an overview of common trends in costings within drug development research, as well as a summary of common pitfalls to consider when apportioning costs.
Year one – drug discovery
As this stage R&D is very intensive, one of the major sources of R&D expenditure within this period is likely to be staffing costs. Staffing expenditure claimed will consist of a proportion of gross salary, employer national insurance and employer pension contributions paid in respect of the employees.
Direct laboratory staff involved in drug synthesis and testing would likely to have relatively high project time apportionment. This will generally consist of researchers, laboratory assistants, and more senior technical staff overseeing the project. Depending on their involvement within the project, support staff in administration or clerical-based roles may also have apportionments, though this is more likely to represent a much lower proportion of their overall time than those involved in the direct research.
If researchers use timesheets to calculate project involvement, these should be utilised, whilst accounting for any non-qualifying activities the employee might have carried out on a project (such as non-scientific cleaning, repair, and maintenance activities). It is often more likely that a percentage for the period as a whole is estimated for each worker, based on a fair and reasonable apportionment. Whilst each apportionment should broadly reflect the specific employee’s job role, it is more important that it is accurate to the individual, based on their personal involvement in the project over the period. It is important to note that no employee should have 100% of their time claimed, regardless of the extent of their project time. This is because HMRC will expect that every individual will have to account for at least some non-qualifying admin time.
In addition, this stage may also include a significant amount of consumables costs, which could take the form of chemicals and other materials used within drug synthesis, or other laboratory consumables. The key point with consumables is that the materials must be used and consumed/transformed in the course of the project and cannot be sold or later used for other purposes. Consumables can therefore even consist of single use masks, gloves, test tubes, or any form of toxicology research kits used in the research, even if it is not biological material that forms the basis of a candidate compound. Due to this requirement, it is very important that specific costs are analysed to ensure only costs that are used and consumed are claimed. It is a good idea to set up your accounting software with R&D costs saved in specific R&D ledger codes to better organise these expenses.
Consumable costs can also consist of a proportion of water, fuel, and power costs related to the project. In projects involving the use of higher output laboratory equipment, this can form a significant amount of spend within these earlier stages. These amounts will generally consist of a fair and reasonable apportionment. Payments for any specialist software involved directly in the research may also be claimed upon, provided they are used directly within the research.
Year two – preclinical development
As this stage R&D is likely to remain very intensive, it is also likely that staffing costs will form a significant amount of the total spend for the period, with similar apportionments for direct laboratory staff members in the beginning of the testing phase of the project.
It is quite common for researchers to contract parts of this testing process to another party, which presents some potential issues that need to be considered when calculating the project expenditure. Payments to subcontractors can be claimed, provided they are involved in qualifying project activities, though all relevant costs must be restricted to 65% of the amounts paid to the subcontractor for the period, unless the party is a linked enterprise. Where a subcontractor has also carried out non-project work a fair and reasonable apportionment will need to be made.
Another key concern relates to the ownership of project work. Often the work contracted out will consist of more minor or routine elements of the project. However if this work itself consists of R&D (for example, the development of new testing methodologies), there are specific and complex rules in place regarding which party ‘owns’ the R&D and therefore which party will be entitled to claim the costs associated with the work. If you are seeking to contract out non-routine project activities it is therefore important to ensure that this is discussed with a competent R&D tax advisor to ensure the correct treatment is taken.
Externally provided workers are another potentially quite significant cost that can arise during this phase of the project. Externally provided workers consist of workers that are not employees of the company but are otherwise paid through an employment agency or a similar organisation. Typically externally provided workers are viewed as an extension of the company’s own staff and should be considered separately from subcontractors.
Externally provided workers often consist of employees from connected companies. If a drug development research company forms part of a group, it can be common for certain parts of the research to be carried out by a linked company. Where this occurs and costs are recharged to the claimant company, these amounts can form part of the total project qualifying expenditure for the period.
Year three – clinical development
From this point in the project it is likely that there would be a reduced proportion of staffing costs for lab-based employees as less and less of their project time relates to seeking to achieve the scientific advance or resolving the project’s uncertainties. This may also mean that the overall qualifying expenditure as a whole may start to lessen compared to the earlier periods.
For this phase of the project a potential source of qualifying expenditure will be payments to clinical trial participants. These costs represent any payments made to the subject of a trial in return for participation in the trial. It is important to note that payments to clinical trial participants will only form qualifying expenditure where they relate to trials involving “the development of a health care treatment or procedure.” Any project involving a drug or treatment that is not considered health care would therefore be ineligible for clinical trial payments.
An additional consideration relates to any subcontractors, staff, and externally provided workers that are based overseas. For accounting periods beginning on or after 1 April 2024 these costs will be ineligible. The exception to this is if there are conditions necessary for the purposes of R&D that are not present in the UK, which are present in the location the R&D is undertaken, that would be wholly unreasonable to replicate in the UK.
This means that when subcontracting overseas there must be a geographical, environmental, or social condition in place that cannot be replicated in the UK, or some form of legal or regulatory requirement for the work needing to take place overseas. In the context of drug development, it is very common for clinical trials to take place in the EU and US for overseas regulators to license the drug as safe and effective for use in other countries.
This would likely form a regulatory condition for work taking place overseas, as these regulators would not allow for drugs to be licenced unless this testing takes place abroad. In this case provided the subcontracted work would otherwise qualify these costs should be allowable. This is however a complex area so careful assessments should be made by an R&D tax advisor into the specific circumstances of any subcontractor based overseas before deciding to include such expenditure within a claim.
Year four – post launch
At this stage it is unlikely that much of the project spend would form qualifying expenditure for purposes of an R&D tax relief claim. This is because there is unlikely to be any remaining qualifying consumables spend, and very few staffing, externally provided workers, or subcontractor activities would be expected to relate to qualifying project activities, unless there is any further evaluation and testing work required post launch. At this stage it is likely the Company has moved onto new projects to break fresh ground!
The above example demonstrates some of the complexities in evaluating R&D costs across the lifecycle of a drug development project. Whilst this represents a very generic example, specific project costs can vary dramatically depending on the nature of the research company, the project activities and the overall advance sought. One of the key things to consider is that all apportionments year on year should be fully evaluated to ensure that they are reflective of project spend for the period. To assist with this and to prevent some of the more complex pitfalls and other issues in preparing a claim for R&D tax relief, it is important to utilise an experienced R&D tax advisor.
