Best Practices For Tracking R&D Tax Credits In Xero Software

The Research and Development (R&D) Tax Credit is a valuable incentive for businesses investing in innovation. However, proper tracking of eligible expenses is critical to claim the credit effectively and remain compliant with tax regulations. Xero, one of Hive's powerful accounting software partners, offers tools to streamline this process and keep your records organized.

Here’s a step-by-step guide and best practices for setting up and tracking R&D tax credits in Xero.

1. Set Up a Dedicated R&D Tracking Category

Using Xero’s Tracking Categories is an efficient way to separate R&D expenses from your general ledger.

How to Do It:

1. Go to Settings > Advanced Settings > Tracking Categories.
2. Create a new category, such as “R&D Activities” or “R&D Expenses.”
3. Add options within the category to represent specific projects or departments (e.g., “Project Alpha,” “Project Beta”).

Best Practice:

Keep the tracking categories granular enough to capture specific activities but not so detailed that it becomes cumbersome to maintain.

2. Create Expense Accounts for R&D

Set up dedicated expense accounts to capture costs directly tied to R&D activities.

How to Do It:

1. Go to Settings > Chart of Accounts.
2. Add new accounts under the appropriate category, such as:
   • Wages – R&D
   • Materials – R&D
   • Contractor Fees – R&D
3. Assign these accounts to the corresponding tracking categories.

Best Practice:

Label these accounts clearly for easy identification when running reports or preparing documentation for tax filings.

3. Record Employee Time for R&D Projects

A significant portion of R&D expenses often comes from employee wages. Accurately track the time employees spend on R&D activities to allocate wages properly.

How to Do It:

1. Use Xero’s Payroll Tracking Categories to assign hours to R&D projects.
2. Set up timesheets or integrate a time-tracking tool like Deputy or Harvest to record employee hours.
3. Link payroll expenses to the R&D-specific expense accounts.

Best Practice:

Ensure employees record their time consistently and allocate it accurately to R&D tasks.

4. Track Contractor and Supplier Costs

Expenses for contractors and suppliers involved in R&D activities are also eligible.

How to Do It:

1. Assign contractors or supplier bills to R&D expense accounts.
2. Use the tracking category for the corresponding project to link costs directly to eligible activities.
3. Attach supporting documents (e.g., invoices, contracts) to transactions in Xero.

Best Practice:

Regularly review these transactions to ensure they meet R&D tax credit criteria.

5. Attach Supporting Documentation

Xero allows you to upload and attach documents to transactions, making it easier to stay audit-ready.

How to Do It:

1. When entering an expense, click Add Files to upload supporting documents such as receipts, contracts, or time logs.
2. Use Xero’s Hubdoc integration to automatically fetch and organize invoices and receipts.

Best Practice:

Maintain a habit of attaching documentation at the time of data entry to avoid gaps later.

6. Generate R&D Expense Reports

Xero’s reporting tools make it easy to generate summaries of your R&D expenses.

How to Do It:

1. Go to Reports > Profit and Loss or Account Transactions.
2. Filter the report by your R&D tracking categories or accounts.
3. Export reports for review and submission during tax filing.

Best Practice:

Run monthly or quarterly reports to stay on top of R&D expenses and ensure they align with your credit claims.

7. Review and Reconcile Regularly

Regular reconciliation ensures your records are accurate and compliant.

How to Do It:

1. Match all R&D-related transactions in Xero with your bank statements.
2. Check that expenses are correctly categorized and linked to the appropriate tracking category.
3. Work with a tax professional to review your records and confirm eligibility.

Best Practice:

Schedule a monthly review to catch errors early and maintain clean records.

8. Collaborate with HIVE KPO

While Xero makes tracking easier, claiming the R&D tax credit requires proper interpretation of tax laws. If you are needing support with your R&D Tax credit or accounting support within XERO, reach out to our Hive KPO Team.