Capitalised development costs and R&D tax relief

Capitalising development costs in your accounts does not stop you claiming R&D tax relief on them. Where the spend is revenue expenditure for tax purposes, section 1308 of the Corporation Tax Act 2009 lets the company deduct it when it is incurred, even though the accounts show it as an asset. Relief then follows the spending, not the later amortisation, and the same cost cannot be relieved twice. Genuine capital items are different: they sit outside R&D tax relief but may qualify for R&D capital allowances.

Why this comes up

Many technology, engineering and life sciences companies capitalise development costs. Under FRS 102, a company can choose between writing development costs off as incurred and capitalising them once the recognition criteria are met. Under IAS 38, capitalisation is required once its criteria are met. Either way, the cost moves from the profit and loss account to the balance sheet and is then written off over the asset's useful life.

That raises an obvious question for R&D tax relief. If the P&L never shows the full cost in the year, how does the claim work? The answer depends on the tax treatment, which does not simply follow the accounts.

Accounts versus tax

HMRC's R&D manual says that capital expenditure is excluded from R&D tax relief, but that the accounts treatment is not conclusive of whether spend is capital or revenue for tax purposes. A cost you have capitalised in the balance sheet may still be revenue expenditure for tax, with the usual principles on capital and revenue deciding.

So there are two questions, and they have different answers:

• Is the spend revenue or capital for tax? This decides whether it can be in an R&D claim at all.
• If it is revenue for tax but capitalised in the accounts, when is the relief given?

Revenue spend capitalised in the accounts: section 1308

Section 1308 deals with the second question. Where a company incurs non-capital R&D expenditure and brings it into account as part of the value of an intangible asset, the expenditure can still be deducted in calculating trading profits, and counts for the R&D reliefs.

HMRC's manual describes three conditions: the spend is recognised as a P&L deduction or as an intangible asset, tax law does not otherwise prevent a deduction for the period, and the expenditure is incurred in the accounting period. No separate claim is needed. Relief arises when the expenditure is incurred, not when it appears in the accounts.

The section also prevents double relief. If the cost is deducted when incurred, the company cannot also deduct the amount written down on the asset, to the extent it reflects that expenditure, and a deduction already given in one period cannot be claimed again in another.

A worked example

A company incurs £150,000 of qualifying staff costs on a development project and capitalises them. It amortises the asset over three years at £50,000 a year. Assume the costs all qualify and ignore the PAYE cap and other limits.

If section 1308 applies, relief follows the spend.

• Qualifying expenditure in the year of spend: £150,000
• Merged scheme credit at 20%: £30,000
• Amortisation of the same cost in later years: no further deduction or relief

If the amortisation route were followed instead, relief would arise as the cost is deducted.

• Each of three years: £50,000 qualifying, credit £10,000
• Total credit over three years: £30,000, but spread over three periods

HMRC's ERIS manual includes a worked example of this second position, where a company does not use section 1308 and takes the amortised amounts as deductions. It confirms that qualifying expenditure is generally eligible in the period in which it receives a tax deduction, even if incurred earlier. In practice, the choice of treatment is made in the Corporation Tax computation, and it should be consistent and documented. The figures are our own arithmetic, for illustration, not a recommendation.

The first route brings the benefit forward. It also puts the claim in the period of spend, which affects which scheme and rates apply and starts the clock on the time limit.

Timing and deadlines

A claim must generally be made within two years of the end of the period of account (see claim deadlines). If development costs were capitalised in earlier years and never claimed, the relief may belong to a period that is already out of time. Do not assume that a later amortisation charge keeps the claim open. Ask us to check each period.

Remember also that costs must still qualify. Capitalising a cost does not make it qualifying, and the same qualifying costs and project tests apply.

The ERIS intensity test

For ERIS, the company's relevant R&D expenditure must be at least 30% of its total relevant expenditure. HMRC's guidance refers to amortisation added back under section 1308 when defining total relevant expenditure. If you capitalise development costs, the intensity figures need care, because the same costs can look different in the accounts and in the test. See ERIS and our intensity checker.

Genuine capital items

Equipment, fixtures and similar assets bought for research are capital expenditure and cannot be claimed under R&D tax relief. They may qualify for R&D allowances under Part 6 of the Capital Allowances Act 2001. The allowance is the full amount of the qualifying expenditure, only traders qualify, and a balancing charge can arise if the asset is later sold, demolished or destroyed. Our page on R&D capital allowances explains how to split project spending so that each cost is considered once.

Talk to us

If your company capitalises development costs, tell us early. Book a call and send us your accounts, your capitalisation policy and the periods concerned. We will work with your accountant to see where the relief falls and what it is worth, and you can try the numbers in our benefit calculator. Every claim we prepare is reviewed and signed off by a Chartered Tax Adviser.

This article is general information, not advice. Please speak to us before acting.