The UK government is a firm believer that innovation is at the heart of a strong economy and believes those companies that invest in advancements to science and technology should be rewarded with generous tax incentives. They do this by offering them a R&D tax credits. It’s not just for high tech companies either, R&D tax credits are available to a wide range of businesses but it is estimated that up to 90% of companies who qualify are currently not claiming.
In this article we will look at the ins and outs of R&D tax credits. From spotting which projects may qualify for the relief right the way through to how to make an application.
What Is R&D?
Research & development is work that innovates, introduces and improves products and processes but for this work to qualify for HMRC’s R&D tax relief it must be undertaken by a UK company and “be part of a specific project to make an advance in science or technology“. This is the wording of HMRC which can be a little daunting on first glance and probably explains why 90% of qualifying companies don’t submit claims.
In reality there are lots of companies out there who invest money in developing new processes, new products or services and even companies who are just making improvements to existing ones. Where these companies meet the qualifying criteria and their projects are aiming to advance the overall field (not just their own industry) they may well be able to claim the R&D tax credits.
It is important to point out that the advancement cannot simply be in their own specific field as this stops companies taking technology already utilised in other industries, applying it to their own and then claiming the relief. If however another company has already developed the technology but it’s not publicly known or available then you can still apply for the relief.
How Does R&D Relief Work?
To put it simply a company that qualifies for the relief is able to overstate certain qualifying expenditure within their accounts which in turn reduces the company’s profit and overall tax liability.
If a company is loss making then it can either carry losses forward to offset against future profits or can opt for a payable tax credit. If a company opts for a payable tax credit then the rate of relief is reduced.
A company can backdate a claim for the past 2 financial years and then continue to make a claim annually for any ongoing qualifying projects.
The amount of relief is not a straightforward calculation. It will depend on a number of varying factors including amount of R&D Expenditure, size of the company and if the company is profitable.
Does My Company Qualify?
The criteria for a company to qualify for R&D tax credits are relatively minimal as the emphasis falls mainly on the project rather than the company itself. If your company is a UK company that is subject to corporation tax then it qualifies. The type of relief will depend on the size of the company but as previously mentioned the real question will be whether the project qualifies.
For the project to qualify it must attempt to make an advance in science or technology but cannot be in a social science like economics or a theoretical field such as pure maths. It is not a requirement that the project is successful as by it’s very nature innovation is risky. HMRC appreciate that some attempts to innovate are successful and some are not. In both scenarios the relief would still be available.
To get the R&D relief the company will need to demonstrate that the project:
– looked for an advance in science and technology
– had to overcome uncertainty
– tried to overcome this uncertainty
– could not be easily worked out by a professional in the field
Some real world examples of projects that may qualify for R&D tax credits include:
– Developing new crops with increased vitamin content
– Developing innovative code used in the production of gaming software
– Developing new materials with unique characteristics
– Development of prototype battery with increased storage capabilities
Which Expenses Can Be Claimed?
Assuming a company and the project undertaken meets the qualifying criteria then a number of expenses will qualify for R&D tax relief. Below are some common examples:
– Direct Staff Costs
– Materials
– Overheads
– Equipment
– Software
Above are just some examples of wholly allowable costs. There are also some costs that are allowed but at a reduced rate, such as subcontractor costs where only 65% of cost is usually allowable.
Of course there are also a number of costs that cannot qualify for the relief which include rent, travel expenses, production costs, patents and trademarks.
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Relief For SME’s
For the purposes of R&D tax credits a small or medium sized enterprise is one that has less then 500 employees plus either of the following:
– Annual turnover less than 100 million euros
– Balance sheet less than 86 million euros
It is important to consider whether the company applying for the relief is part of a wider group or is working for a company that would be considered large when considering the above criteria. Guidance to help you determine if your company is an SME can be found on the HMRC website.
If the company qualifies as an SME then it will be able to make an additional deduction of 130% of qualifying expenditure. This is on top of the 100% already claimed as the expenditure was incurred. This creates an “enhanced deduction” of 230%. This enhanced deduction then attracts corporation tax relief as would any other expenses in the accounts at a rate of 19%.
If the company is loss making then there will be no immediate tax relief in the current year. It can choose to either carry the enhanced loss forward to offset against future profits or surrender the loss to HMRC in exchange for a payable tax credit providing the company is a going concern but remember the payable credit is at a reduced rate so the net saving will be less.
The payable tax credit for SME’s is 14.5% of surrenderable losses and the surrenderable loss is the lower of unrelieved trading losses or 230% of qualifying R&D expenditure.
Example (loss making company):
| Description | Amount |
|---|---|
| Losses before deducting R&D Expenditure | 50,000 |
| Qualifying R&D expenditure | 70,000 |
| Surrenderable loss is lower of: | |
| (£50,000+£70,000) or (£70,000 x 230%) | 120,000 |
In this case the lower of the two is the unrelieved trading losses so the payable tax credit would be £120,000 x 14.5% = £17,400. The payable tax credit is not taxable and can be used for any purpose including paying dividends.
It is worth noting that relief under the SME scheme is considered a notifiable state aid and a company cannot receive another notifiable state aid for the same R&D project. This means that if a company is already receiving grants or subsidies that fall into this category in relation to it’s R&D project then it will not qualify under the SME scheme but can still apply under the RDEC scheme below.
RDEC Scheme
The research and development expenditure credit is a different type of R&D relief and can be used by companies who don’t qualify as small or medium under the above guidelines as well as SME’s who have been subcontracted by a large company or who have received a grant or subsidy for their R&D project which makes them unable to claim under the SME’s scheme.
For the 2020-21 tax year the RDEC percentage is 13% which is applied directly to qualifying R&D Expenditure and usually discharges current liabilities or could result in a cash payment for loss making companies or companies who have already paid their corporation tax liability. For profitable companies the credit must first be offset against any corporation tax liabilities outstanding before it would result in any cash payment. In contrast to credits received under the SME scheme any RDEC tax credits a company receives are taxable under corporation tax. By the time the credit is taxed at 19% the net cash benefit to the company is around 10.5%.
Example (large company)
| Description | Amount |
|---|---|
| Qualifying R&D Expenditure | 500,000 |
| 13% RDEC Credit added to income | 65,000 |
| Additional Corporation Tax Libility | 12,350 |
| Net Benefit To Company | 52,650 |
How To Claim
For both SME and RDEC claims the amounts will need to be recorded on the company tax return (CT600) however each claim needs to be supported by technical and financial documentation which will be assessed by a claims processor at HMRC.
There is no set framework that the supporting evidence needs to follow but it should explain how a project:
– looked for an advance in science and technology
– had to overcome uncertainty
– tried to overcome this uncertainty
– could not easily be worked out by a professional in the field
On top of this there will be certain things HMRC want to see detailed in the evidence in order to process the claim.
– Summary of work undertaken
– Details of staff and subcontractors working directly on the project
– Detailed records of expenses that qualify for R&D relief
The aim of the supporting evidence is to demonstrate to HMRC that the R&D relief has been calculated and applied correctly. The supporting evidence is an essential part of the process and is often what causes claims to be delayed or fail. For this reason it is important to speak to a professional who can assist with your claim.
Need Assistance?
It’s a lot of information to take in but with so many qualifying companies currently missing out on these significant tax credits it’s a good idea to speak to one of our tax specialists to discuss your R&D project without delay. Our team can help your company identify qualifying projects and submit a successful claim to HMRC.
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Adam Hill
Practice based accountant with over 10 years experience, specialising in SME's, Freelancers and Personal Tax. "I take pride in proactively recognising tax planning opportunities on behalf of clients to help them operate more efficiently."
