Connected party cost traps in R&D claims
If HMRC reviewed your connected party costs today, would the economic reality fully support your claim position?
Connected party costs are entirely legitimate in R&D claims.
They’re also one of the fastest ways to trigger HMRC scrutiny if handled incorrectly.
Many groups operate with shared staff, group service companies, or intra-group subcontracting arrangements. That in itself isn’t an issue.
The problem arises when the R&D cost rules don’t align with how the group structures its internal charging model.
The most common connected party cost traps
1. Claiming the invoiced amount instead of actual cost
For connected subcontractors, the rules typically restrict relief to the actual underlying cost, not the uplifted or commercial recharge value.
If a group company invoices £150,000 but its actual payroll and attributable cost was £110,000, the qualifying figure is usually the lower economic cost – not the invoice total.
This is a frequent enquiry trigger.
2. Circular or layered recharges
Where costs pass through multiple entities (e.g. OpCo → ServiceCo → HoldingCo), HMRC will look at the substance over the form.
If the same payroll cost is effectively being marked up or duplicated across entities, risk increases significantly.
3. Lack of clarity over who undertook the R&D
If one group company employs the engineers but another company claims the relief, HMRC will examine:
- Who was seeking the technological advance?
- Who bore the financial and technical risk?
- What do the contracts actually say?
The legal and economic reality must align with the tax position.
4. Poor documentation of cost breakdown
HMRC may request:
- Payroll summaries
- Intercompany agreements
- Recharge calculations
- Evidence of how qualifying time was determined
If the only support is an intercompany invoice, that rarely satisfies a detailed review.
5. Transfer pricing blind spots
For larger groups, connected party R&D costs may overlap with transfer pricing considerations. If margins or recharges don’t reflect economic substance, that can widen the enquiry beyond just R&D.
Connected party structures are common and often commercially sensible. But from an R&D perspective, they require precision and transparency.
Pause for thought
If your claim includes connected party costs:
- Are you claiming actual cost or recharge value?
- Can you demonstrate how the cost figure was calculated?
- Do your intercompany agreements support your position?
- Would the economic substance stand up under scrutiny?
R&D relief remains valuable, but group structures demand careful handling to ensure the claim reflects reality, not accounting mechanics.
