R&D tax credits are a government-designed incentive to encourage businesses to invest in research and development.
The amount of tax credit a business is entitled to depends on whether it accesses the SME scheme or the large company scheme (RDEC).
In this blog, Anne Rose, Head of Tax at Burgis & Bullock, discusses what an R&D tax credit is, who can claim, what expenditure qualifies and how to calculate the tax credit your business is entitled to.
What is R&D tax relief?
R&D tax credits reward innovative behaviour and companies that seek to develop new technologies, products and process. This in some cases will include improvements to existing technologies.
Businesses use R&D tax relief as a means of getting cash back into a business and to provide continued support to research and product development.
Find out more about R&D tax relief, how to claim and who is eligible by reading our recent blog on the subject: How to claim R&D tax credits for your growing startup today
Calculating your qualifying expenditure for R&D tax credit
The first stage of any R&D tax credit claim is to identify which projects meet HMRC’s definition of qualifying expenditure, and importantly, how much of the work done in the accounting period of claim will qualify.
Here’s a reminder of the qualifying criteria you must hit:
- Must be performing qualifying research and development activities
- Qualifying research is defined as an activity that has a potential to contribute to industry-wide technological or scientific knowledge
- This includes any process involving experimentation, exploration, creation or invention where there is no certainty whether any results will be achieved
The R&D tax relief will be calculated for an accounting period. Take some time to identify which projects qualified within that period and then delve into the individual projects for the qualifying costs.
This will broadly be the costs of employing people who have worked directly on the R&D project – that includes the employers National Insurance and pension contributions, in addition to salary and bonuses.
By the end of this process you will know who has been working on the project, how much time they have spent doing so and what portion of their total salary costs will be covered under qualifying expenditure.
In certain limited circumstances, you can also include the relevant costs of people involved in indirect activities associated with the R&D – this for example could be people employed to collate results and write-up reports.
After analysing the people side of the equation, assess the consumables that have been used during the course of the R&D work. That could be materials, loose tools or any other consumable items – for example prototypes and testing equipment.
Finally, review subcontractor costs and software costs. A common example for subcontracting would be a subcontractor to manage testing of a product, and for software a business may require a unique programme to overcome a hurdle in the design process.
Now you have your figure for qualifying expenditure, you can see which scheme you are entitled to and the associated tax relief with that scheme.
SME R&D relief allows your company to deduct an extra 130 percent of your qualifying R&D costs from your yearly profit
For example, if you have £100 of qualifying expenditure, you are entitled to an additional corporation tax deduction of £130. This will lead to a reduction in tax payable of 130 x 19% = £24.70.
For every £100 of qualifying expenditure you get £25 off the tax bill – that’s a rough guide!
The SME scheme is very generous but that assumes you are tax paying, if you are not tax paying /making a loss then you get two options:
- You can make your loss bigger, carry that forward and get tax relief when you start making a profit again – because you’ve got more losses to set off. If that’s next year, when the tax rate is still 19%, it will still give you £24.70 but not until you start having some tax to pay.
- If you don’t want to do that and you need cash, you can convert your £130 (in this example) into a cash payment from HMRC instead of it reducing your tax charge for the year. You get any cash-back at a lower rate of 14.5%. You would be looking at £18.85 back per £100 of qualifying expenditure.
In summary, if you owe tax then HMRC will reduce your tax bill. However, if the business doesn’t owe any tax, HMRC will give cash-back instead but it will be at a lower rate.
Businesses sitting on a loss have to think:
- If you’re really short of cash it’s a good way of getting cash back.
- You’re not short on cash and you think you will make big profits when Covid-19 is over, then you are better to carry it forward because you will get the relief at a higher rate – which will be a lot higher when the tax goes up to 25%!
Find out if you are eligible for the SME scheme: https://www.gov.uk/guidance/corporation-tax-research-and-development-tax-relief-for-small-and-medium-sized-enterprises
The other scheme is for larger companies and is also known as the RDEC. There are two instances where smaller, SME sized businesses, might end up having to claim under the RDEC scheme – which isn’t as generous as the SME scheme.
- A business is part of a larger world-wide group which takes it over the threshold – the business might be the only UK company in the group, but that doesn’t matter. It may seem unfair but those are the rules.
- A business has received a government grant, such as an Innovate UK grant to support an R&D project. If that has been received, a business can only claim under the RDEC – not SME scheme.
The RDEC scheme is nowhere near as generous, but unfortunately businesses have no choice which scheme to be in – it’s a simple question of numbers.
For the large scheme, you still do exactly the same to work out qualifying expenditure. In our example the qualifying expenditure is £100. This time, unlike the SME scheme, you don’t take 130 per cent and you don’t set it off against your profits.
It’s an absolute credit and the rate sits at 13 per cent. So, if you have a £100 of qualifying expenditure, that will result in a £13 tax credit. If the business is tax paying, HMRC will literally give you £13.
However, this credit is taxable and increases your tax liability. On that you would pay 19 per cent in tax, which in this example would result in a net cash injection of £10.53 in this example of £100 expenditure.
That’s a big drop from the 25 per cent rate available through the SME scheme.
While the SME is much better, the RDEC is certainly still worth having and can help businesses to achieve their R&D goals.
More information on the RDEC scheme: https://www.gov.uk/guidance/corporation-tax-research-and-development-tax-relief-for-large-companies
How we can help?
Our team is on hand to support you with any guidance around R&D tax credits. We are experts in this field and our vast experience will help to guide you through the process.
We offer an introductory phone call for no fee and would encourage any SMES or large businesses considering a claim to get in touch.
If you’re not sure, don’t worry, and if you do not have time to read all of the HMRC guidance, don’t worry – talk to an expert instead.