The UK Government recognises that encouraging innovation is a vital component in a strategy for improving the UK’s productivity, performance and competitiveness. As a result, the research and development (R&D) incentives for both small and medium size enterprises (SMEs) and large companies have been enhanced in recent years to encourage and reward greater innovation in the UK. More information on how these incentives work is detailed below.
How do R&D tax credits work?
Companies, defined as Small or Medium-Sized Enterprises (SMEs) or Large Companies, (see definitions below) that incur expenditure on research and development (R&D) may be able to claim enhanced UK corporation tax relief. SMEs may be able to obtain an enhanced 230% deduction or, if loss making, a payable tax credit. The scope for identifying R&D is huge – in fact, it exists in almost every single sector of the economy. And if you’re making a claim for the first time, you can typically claim R&D tax relief for your last two completed accounting periods.
Is My Business Eligible for R&D Tax Credits?
To benefit from R&D tax incentives, you must:
- Be a limited company in the UK that is subject to Corporation Tax.
- Have carried out qualifying research and development activities.
- Have spent money on these projects.
What this means for small companies
The R&D tax credits available to small and medium enterprises (SMEs) have been substantially increased over recent years. The super-deduction available has increased to 230% from 1 April 2015 with the cash back available to loss making SMEs now 33.35% of the qualifying expenditure.
The rise in the rate of relief for SMEs means that the cash value of claims for tax paying companies is £26 for every £100 of R&D spend from April 2015 (based on a 20% tax rate) and £33.35 for companies with losses.
These changes have made claiming R&D credits a lot more valuable to SMEs.
SME Defined (Most companies, including start-ups, fall into this category):
- Fewer than 500 staff, and
- not more than €100 million turnover or €86 million gross assets, and
- less than 25% of its capital or voting rights owned by one or more companies that are not small or medium-sized
As well as being an SME, the company must be a going concern and carry on a trade. It must own any intellectual property that might arise from the R&D project. The expenditure must be revenue expenditure, deductible in computing the profits of the company’s trade in the period. Revenue expenditure which has been capitalised for accounting purposes may still qualify for the relief.
First time claiming the R&D Credit (SMEs only):
HM Revenue & Customs (HMRC) has an ‘advance assurance’ service for SMEs which have not claimed R&D tax credits before and have an annual turnover of £2 million or less and less than 50 employees. If HMRC is satisfied that the R&D to be undertaken will qualify for the relief this will be confirmed by the advance assurance and for the first 3 accounting periods of claiming R&D tax relief, HMRC will allow the claim without further enquiries.
What this means for large companies
Large company Defined:
In short, large companies are companies which are not SMEs, including those with:
- 500 staff or more
- More than €100 million turnover or €86 million gross assets.
HM Revenue & Customs (HMRC) have made the large company regime much more generous by introducing the Research and Development Expenditure Credit (RDEC).
RDEC allows larger companies from 1 April 2013 to recognise the benefit of their R&D claim effectively as a grant against cost, opposed to within the tax line, which helps add visibility. Loss makers are now also able to claim cash back from HMRC.
A company is entitled to a RDEC at the rate of 11%* of its qualifying R&D expenditure for an accounting period. It brings the RDEC into account as an additional receipt of the trade for the accounting period. Please note that RDEC can also be claimed by SMEs that fail to meet certain of the criteria for SME relief, although the relief given is not as favourable as that under the SME regime.
The credit is used as follows:
- It is first set against the corporation tax liability of the company for the same accounting period
- Any balance is then reduced to a net of tax amount. The notional tax amount is available to discharge future corporation tax liabilities
- Any balance remaining is capped by the amount of PAYE and NICs paid by the company in respect of the R&D staff. Any amount which exceeds the cap is carried forward and treated as an expenditure credit for the next accounting period
- The amount remaining then discharges corporation tax liabilities of the company for any other period
- If the company is a member of a group, it may surrender any amount remaining for a corresponding accounting period
- Any remaining payable credit element is then applied in discharging any other outstanding liability of the company to HMRC, such as VAT or PAYE
- After all restrictions and set offs have been applied, the remaining amount is payable in cash.
From 1 January 2018, the credit rate increased to 12% (from 11%), providing a net cash benefit of 9.72% at a 19% tax rate. Unlike the ‘old’ super-deduction scheme, which only had a cash value if the company was paying corporation tax; RDEC is payable regardless of the tax position, subject to some restrictions including a cap based on PAYE and NI.
Up until 1 April 2016, you had the option to continue claiming under the previous super-deduction R&D scheme, instead of the new RDEC. The old scheme works by providing an additional 30% super-deduction for tax purposes on qualifying R&D expenditure. £10m of qualifying R&D spend would result in an additional deduction of £3m, which at a 20% tax rate results in a £600k cash saving.
Some Details to be Aware of:
If you are classed as an SME for R&D tax credit purposes, your next step will be to make a claim via the SME R&D tax credit scheme. If you are a large company, your next step is via the Research and Development Expenditure Credit (RDEC).
However, there are a few factors, like grants and subcontracting, that can restrict an SME from accessing the SME scheme. This means you may need to make a claim via RDEC – or via both schemes.
SME R&D tax credit scheme
What counts as R&D?
The HMRC R&D criteria are purposefully broad. Whatever size or sector, if your company is taking a risk by attempting to ‘resolve scientific or technological uncertainties’ then you may be carrying out qualifying activity. This could include:
- Extending overall knowledge or capability in a field of science or technology.
- Creating a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology.
- Making an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes.
- Using science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way. An example would be a product that has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner.
R&D can take place in any sector, from abattoirs to yacht building and design. If you’re not sure if you can achieve the results you are after, or you don’t know how to achieve it in practice, you could be resolving technological uncertainties and be carrying out qualifying R&D.
Within the government’s accepted research and development definition, R&D does not have to be successful to qualify. You can also include work undertaken for a client, as well as your own projects.
What costs qualify for R&D tax credits?
When putting together an R&D tax credit claim, we look for the following types of R&D qualifying expenditure:
- Staff, including salaries, employer’s NIC, pension contributions and reimbursed expenses.
- Subcontractors and freelancers.
- Materials and consumables including heat, light and power that are used up or transformed by the R&D process.
- Some types of software.
- Payments to the subjects of clinical trials.
How much is an R&D tax credit claim worth?
R&D tax credits are calculated based on your R&D spend. To make an R&D credit calculation, you need to identify qualifying expenditure and enhance it by the relevant rate (see below). This produces your ‘enhanced expenditure’.
When you deduct your enhanced expenditure from your taxable profits, or add it to your loss, it will result in:
- a Corporation Tax reduction if you are profit-making
- a cash credit if you are loss-making
- or a combination of the two
R&D tax credit rates
SMEs are able to claim up to 33p for every £1 spent on qualifying R&D activities. The average claim made by SMEs in the UK is £53,876 (2016-17).
Large companies are able to claim up to 10p for every £1 spent on qualifying R&D activities. The average claim made by large companies in the UK is £272,881 (2016-17).
The R&D tax credit rates 2018 are shown in the table below.