This is the first in a series of insights explaining R&D tax credits and looking how your business may potentially be eligible, and what to do next. Iain Gray of MSC R&D - techUK’s R&D Funding & Commercialisation Partner
The UK Government’s R&D Tax Credit scheme encourages and rewards both SMEs and large companies for investing in innovation. It offers a vital means to cut costs and improve cash flow, whilst remaining ahead of the competition.
Over 26,000 claims were made in 2015-2016 – an increase of 19% over 2014-15.
The total value of claims rose to £2.9bn (a 20% increase).
The scheme is complex and requires detailed knowledge and understanding in order to take full advantage of it. Consequently, most companies either don’t claim or under claim. Or, worse still, over claim with no justifiable evidence in the case of an audit by HMRC.
Can You Qualify for R&D Tax Credits?
Although knowledge of the relief is spreading, many eligible companies still do not claim. This is often because companies don’t understand the scope of what R&D projects are eligible and, therefore, don’t feel that what they are doing qualifies. This lack of understanding is preventing companies from benefitting from the schemes and losing out on potentially tens, if not hundreds of thousands of pounds of valid R&D Tax Relief.
If your business is a UK limited company and, in the past two years, you can answer yes to one or more of the following questions, then you could well be eligible:
- Have you manufactured or developed new/existing products, devices, systems?
- Have you developed or improved any software, in house?
- Have you developed bespoke new products for clients which involved you undertaking R&D?
- Have you made efficiency improvements to any of your processes?
- Has there been a requirement to change your processes, products, systems, technical devices or services because of legislation changes?
Other companies may be worried that a poorly constructed or supported claim may lead to trouble with HMRC. This is where a specialist in claim preparation can provide the necessary reassurance that your work qualifies and that the right expenses have been claimed.
R&D Tax Credits Explained
The R&D Tax Credit scheme was introduced by the government for SMEs in 2000 and extended to Large Companies in 2002. Any company developing new products, technology or processes may be eligible.
It is a tax relief scheme, designed as an incentive for companies developing new technology – the more qualifying development work a company does, the greater the relief it can get from its Corporation Tax bill. Even loss-making companies can benefit (in terms of a “Credit”) which can be of particular importance to early stage businesses.
The scheme is one of the most attractive in the world and a company can claim retrospectively for up to two previous accounting years.
The benefits to a company vary according to the level and cost of development undertaken, whether it is an SME or a Large Company, and its Corporation Tax, but it is not unusual for expenditure to run into hundreds of thousands of pounds, with tax relief typically in excess of £30,000 being realised.
How R&D Tax Relief Works
If a company incurs qualifying expenditure (in categories such as staff costs) on R&D, it can enjoy an extra deduction from its taxable profits, so its corporation tax bill will be reduced. If the tax has already been paid, then a refund will be received from HMRC.
For SMEs the rate of enhanced deduction is currently an extra 130% – meaning a cash saving of 24.7% of the eligible R&D cost (assuming the tax rate to be 19%). Not all SMEs (and particularly early stage start-ups) will have taxable profit, so an extra deduction from taxable profits would not be of immediate use to them. Instead, loss making SMEs can convert their losses (attributable to qualifying R&D spend) to cash, at a rate that currently amounts to approximately 33% of their qualifying spend on R&D.
These reliefs for SMEs are very valuable and can provide cash at a critical stage to support the continuing R&D effort.
For Large Companies, the R&D Expenditure Credit (RDEC) provides a cash payment (taxable) of 12% of the qualifying R&D expenditure instead of a deduction from taxable profits. This credit is available even if the company has no other taxable profits.
Is Your Company a Small or Medium Enterprise?
To qualify for the more generous SME relief your company has to have less than 500 employees and either have annual turnover not exceeding 100m Euros, or have total balance sheet assets not exceeding 86m Euros.
In arriving at staff, balance sheet and turnover numbers for your business you have to include:
- the total figures for any linked enterprise (you would test for these in a similar way to deciding if your accounts need to be consolidated), and;
- an appropriate proportion of the numbers for any enterprise that owns 25% or more of your company’s capital or voting rights, and;
- an appropriate proportion of the numbers for any enterprise that your company owns 25% or more of the capital or voting rights for.
The precise definitions of linked and partnership enterprises are based on a modified European Community definition which also includes certain exceptions. To establish whether you are entitled to claim under the SME relief regime, or have to claim under the less generous RDEC regime for larger companies, we recommend you get specialist assistance, as this can be a complicated area. (N.B) The definition of a SME will have to be kept under review as the Brexit process unfolds.
The Rules of R&D Tax Credits
Of course there are rules. The expenditure has to be on qualifying R&D, in line with a published definition. This definition is a broad-based one that goes well beyond blue sky R&D and includes technological and software development up until the technological problems have been solved, and you have something which only requires minor adjustments before it can be used or commercially released. The expenditure on this R&D then has to be checked to make sure it is revenue in nature (rather than capital), and meets rules covering what expenditure qualifies: so for example there are special rules concerning subsidised or subcontracted expenditure, and rules defining what expenditure falls into eligible categories.
The meaning of R&D in the context of R&D Tax Credits is not straightforward and wider than most companies realise. It is not limited to the R&D department. HMRC defines R&D as work that achieves a scientific or technological advance when scientific or technological uncertainty exists.
This can include:
- achieving an increase in overall scientific or technological knowledge or capability;
- significantly improving products, processes, materials or services through scientific or technological development;
- using science or technology to duplicate the effect of an existing product or process in a new or appreciably improved way.
The whole project may not qualify, only the element addressing the technological uncertainty. This is not always easy to identify, but can include planning and managerial activities in some instances. With software R&D, where development is ongoing, identifying the areas of technological uncertainty in projects is critical, as many more routine activities will not qualify. Software R&D can cover a very large part of the development process from testing suitable data sources and filtering techniques through to “fit for purpose” testing of a scaled-up prototype. However, identifying this in a way acceptable to HMRC is a skill developed over numerous claims.
How to Claim the R&D Tax Reliefs
Generally speaking, you have two years from the end of an accounting period to claim the R&D relief for expenditure deducted in that period. A company can prepare and submit its own claims. However, that means they have to understand how the R&D definition is applied in practice, master the detail of what expenditure qualifies under the rules, and also understand how to present this so HMRC understand it and are satisfied by it. The alternative is for you to do what you do best – develop the technology and run your company – and to use a specialist like MSC R&D to prepare the claim for you; most companies choose this route.
Look out for our follow up Insight, looking at just exactly what R&D is.
If you would like a copy of MSC R&D’s Tax Credit Guide, please email email@example.com.UK.