What is R&D tax relief and why you should claim it
Research and Development tax reliefs (R&D tax reliefs) are government schemes, administered through HMRC, to drive productivity and growth in the economy by rewarding UK limited companies for investing in innovative solutions that solve scientific and technological problems.
Why you should claim R&D tax reliefs?
There are several reasons for why you should claim R&D tax reliefs for your company:
- It represents a significant ‘free’ source of cash flow to invest further in developing new products, hiring new staff and ultimately growing.
- Ensures business stability with better financial planning and reduced risk of future investment, which demonstrates that your business is savvy for investors.
- Creates a significant reduction in your current and future tax liabilities.
- You will obtain a competitive advantage (as 75% of companies are missing out of the relief’s benefits) to expand into new markets and facilitate job creation and security.
- Can lead to further funding sources, such as SEIS and EIS.
What is Research and Development (R&D)?
According to the guidelines produced by the Department for Business, Innovation and Skills on the meaning of Research and Development for tax purposes, R&D refers to “work that advances overall knowledge or capability in a field of science or technology, and projects and activities that help resolve scientific or technological uncertainties”.
To show that your project is within the above definition, your claim should explain in a way that can be understood by someone who is not an expert, the following:
- what scientific or technological advance your project is seeking. It is not enough to merely state the process, the functionality being developed or that the project is commercially innovative.
- what scientific and technological uncertainties is the project intending to resolve, and when they started and ended. It is unlikely that technical problems that have been overcome in previous projects on similar systems to be classified as technological uncertainties.
- the methods used to overcome the uncertainties and the investigation and analysis undertaken. This shouldn’t be in great detail, but enough to show it wasn’t straightforward.
- how the project incorporates science or technology that is not readily available in your industry (provide evidence available if needed). You can do this by either showing that others have tried to resolve the uncertainties and failed or by letting the competent professionals working to explain why they consider the uncertainties are scientific or technological uncertainties rather than routine uncertainties.
- how the project relates to your company’s trade (either an existing one or one that you intend to start based on the results of the R&D) and how you intend to use the findings for your business.
Projects that may qualify for claiming R&D may come from sectors such as Clinical Research, Communications & Media, Constructions, Cosmetics, Defence, Product Design, Software Development, Information Technology, App Development etc.
Qualifying conditions – Who can claim
There are two separate R&D tax reliefs:
- The Small and Medium sized Enterprises R&D tax credit (SME R&D tax credit) scheme – it offers a repayable tax credit of up to 33.35% of the eligible spend for loss-making companies and up to 24.7% of the eligible spend for profitable companies.
- Research and Development Expenditure Credit (RDEC) scheme – available for large companies (and in some circumstances for SMEs) and offers an expenditure credit worth up to 9.72% of the eligible spend irrespective of whether the company is a loss-making or a profitable company.
The exact rate your business qualifies for R&D tax reliefs will depend on your Corporation Tax position and whether your business is profitable or loss-making.
The SME R&D tax credit scheme
To be eligible to claim on this scheme your company must be a UK small and medium limited company (partnerships, charities and sole traders cannot claim R&D tax relief as they do not pay Corporation Tax). To be classed as an SME you must:
- have fewer than 500 employees;
- have a turnover of no more than £100 million; or
- have gross assets of no more than £86 million.
Furthermore, the company must be carrying on a trade, or be a new trade arising from the successful outcome of an R&D Project. The company must be undertaking research and development for their own benefit and not as a subcontractor. However, if you are an SME carrying out R&D work for a large company you may be able to claim relief under the RDEC scheme.
Projects already receiving grant funding (in particular innovate UK grants, Manufacturing Advisory Service etc.) are only eligible for tax relief under the RDEC scheme.
The RDEC scheme
It is primarily used by large companies that are subject to UK corporation tax, carry out qualifying R&D, and spend money on those activities.
However, SMEs can also use the scheme in the following circumstances:
- They have received a grant or subsidy: There is a common misconception that if an SME receives a grant it cannot claim R&D tax reliefs at all. Fortunately, this is not the case. One should consider R&D tax reliefs regardless of the fact that the grant’s terms and conditions could have a large bearing on how SME uses the R&D tax reliefs schemes.
- They have carried out subcontracted R&D on behalf of a large business: For example, if an international company subcontracts a software development company to deliver a project for which the software company has to carry R&D work, then the software company can claim relief under RDEC scheme, as well as being paid by its customer. Additionally, if the software company bears the financial risk of that project (i.e. if they fail to deliver it on time or on budget, then they bear the additional costs), then they can still claim for relief and get paid for it by their customer.
What to claim
If you have an eligible project you can claim R&D tax reliefs on a number of costs:
- Material costs – materials used for developing a prototype, costs for software or utilities needed to run the project. Software partly used for R&D can be included at a reasonable apportionment.
- Staff costs – wages and salaries, bonuses, pension contributions and Employers National Insurance. Staff costs can be estimated but is better if there are time records available for the calculation.
- Third-party costs – payment to subcontractors for R&D activity or the cost of hiring workers through an agency to bring in specialist help for support on a project. Payments to universities and non-corporate bodies are eligible under RDEC.
- Indirect costs – management time in focusing the efforts of the R&D, staff time in appraisals, interviewing new employees to be engaged on the project.
- Contributions to independent research (RDEC only) – payments made by large companies to a qualifying body (scientific research body, a charity or a university) that carries put relevant research in the company industry.
You cannot claim for:
- the production and distribution of goods and services;
- capital expenditure;
- the cost of land;
- the cost of patents and trademarks; and
- rent or rates.
How to apply
You can claim R&D relief by entering the total qualifying expenditure on the Company Tax Return form (CT600). The normal time limit for making your claim is two years after the end of the relevant corporation tax accounting period.
Companies who are making their first R&D claim and have less than £2,000,000 in turnover and fewer than 50 employees, can qualify for Advance Assurance. If Advance Assurance is granted, HMRC will send an agreement letter explaining the company’s responsibilities and what happens if the R&D activities change. Advance Assurance is proof that a company will get R&D tax relief if the claim is within the first 3 accounting periods and in line with what was previously discussed and agreed.
Things to consider
- The more documented is the research before the start of the project, the more likelihood of success.
- Grants are very specific, if a project moves in a different direction after the funding has ceased, you may be working on a different project with different technological or scientific uncertainties, so you may claim further R&D.
- Subsidies projects are eligible for claiming R&D tax reliefs, but only the unsubsidised element of the claim can be included. Consequently, if you are working in partnership with another business, you have to make sure that the subsidised expenditure is incurred for items that are not eligible for the tax relief.
- Careful consideration needs to be given when your company has external investors or is in a group, as the limits imposed by the SME R&D Tax credit scheme extends to:
- Linked enterprises – ones in which there is 50% or more ownership, through companies and individuals;
- Partner enterprises – ones where there is 25% or more ownership through companies.
- If you are a large company and apply under the RDEC scheme, it pays to prepare a robust methodology to ensure your claim value is maximised and supported with a robust methodology. This is because of identifying qualifying expenditure in a large company’s accounts can be more demanding than in an SME especially because the sums involved are often a lot larger.
The start and end of a project for R&D tax purposes
To ensure that your company claims the right amount of relief, it is important to know when an R&D project starts and ends.
The R&D activity starts when you begin working to resolve the scientific and technical uncertainties surrounding your project. This happens once you have identified and outlined that the current state of knowledge within your project’s industry has not provided a solution to the scientific and technical issued that need to be resolved.
A project ends once the scientific or technical uncertainty is resolved or the work to resolve has ceased. This can result in a product, a device or process ready to be tested or go into production. The R&D activity can also end if you decide not to take the project forward.
Top tip: Your R&D activity may restart if you find another scientific or technological uncertainty after you’ve started producing the product. If this happens, you can claim for further R&D while you try to resolve it.
How does R&D tax relief interact with SEIS/EIS schemes
On 24 January 2019, HMRC R&D Consultative Committee has confirmed that a company can benefit from both the EIS/SEIS and R&D tax reliefs schemes.
Therefore, a company may focus initially on getting SEIS in place so it could approach early-stage investors, and after securing the initial investment, the company may further apply to EIS scheme to attract finance for high-risk R&D activities. Meanwhile, if the R&D project meets the guideline on the meaning of research and development, the company can claim R&D tax reliefs for eligible expenditure.
By claiming collectively EIS/SEIS and R&D tax reliefs, the companies have the opportunity to direct all their resources on innovation and company growth rather than struggling to seek venture capital or private equity investment when they are at the beginning of their growth cycle.
Read more about how to apply for EIS and SEIS advance assurance.
How we can help
If you are creating a new or improved product, process or service, your business might be entitled to claim for R&D tax relief.
If you would like assistance with claiming R&D tax reliefs, we offer a no-cost and no-obligation call of up to 20 minutes to first discuss your matter and requirements before confirming a scope of work and quote. This can be arranged by sending your details together with an overview of your matter through our contact form.
This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited 2023.