The pharmaceutical industry is generally well understood by HMRC, although the rules have not kept pace with the recent trend in the industry towards more small companies contributing to parts of the drug discovery and development pipeline. This case focusses on a client building a successful business working as part of the drug trials process and had previously been advised the would not qualify for R&D tax credits because they were only conducting one part of a wider process.
This client was set up by a group of senior scientists with long service at one of the major pharmaceutical companies. When that company relocated across the country, they instead set up their own business to allow them and other similarly highly qualified specialists to work on drug development projects on a flexible basis.
Whilst there was an awareness of R&D tax credits, the work did not fit the classical SME R&D process as the projects worked on were only a small (albeit vital) part of the larger resolution of uncertainty that drug trials represent.
When we were engaged we began by considering the rules that allow organisations performing R&D as a subcontractor to claim under the RDEC scheme (formerly known as the above the line scheme). Under this scheme a large company is not allowed to claim subcontracted R&D costs (in contrast to the SME scheme where 65% of these can be included). Where the subcontractor is themselves an SME, they are allowed to make the part of the RDEC claim that the contracting company cannot. This is worth about one third of the tax savings of the SME scheme, so it is still a worthwhile tax benefit.
Our approach involved a detailed review of all contracts placed with our client to ensure they were actually for subcontracted R&D, and not just a regular supply of services. We also conducted due diligence on all the company’s clients to ensure they met the requirements of the RDEC scheme. Although this largely requires that they are large (> 500 employees) organisations, we were also able to establish the qualifying status of some smaller clients based outside of the UK as well. This was vital given the growth in smaller “boutique” pharmaceutical companies and CROs now engaged in drug development.
A final complication was that many of the specialists used to deliver the R&D were themselves self-employed or operating through limited companies. This required another detailed contract review to establish the staff were not themselves subcontractors, without disrupting their individual IR35 arrangements.
Once we established the qualifying contracts, organisations and staff we were able to use the client’s excellent record keeping system to calculate the relevant costs. We could then calculate the RDEC and apply it to the tax computations with the support of the client’s accountant. The resulting RDEC credit has largely eliminated corporation tax payments for our client (savings of about £60k per year). They have not been able to take full advantage of the fact that RDEC also allows surplus credits to be paid in cash due to the fact that much of their manpower is external and so do not have their PAYE and NI paid by our client.