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R&D Tax Credit Rules

The scheme details

R&D tax credits enable companies that incur costs in developing new products, processes or services to receive an enhanced tax deduction. In the case of an SME company that is loss-making, an actual cash payment as a credit from HMRC can be achieved.

R&D tax credits are a very valuable source of funding for many businesses.

The R&D tax credit scheme is an HMRC incentive designed to encourage innovation and increased spending on R&D activities by companies operating in the UK, although the work doesn’t necessarily need to be physically carried out in the UK – another major misconception by many companies and advisors.

Here is a quick link to the page covering the R&D tax credit rules on the HMRC website

R&D tax credit eligibility

The Government has set out four key questions for determining whether the work being done meets the eligibility criteria. These are:

1. What is the scientific or technological advance?
2. What were the scientific or technological uncertainties involved in the project?
3. How and when were the uncertainties actually overcome?
4. Why was the knowledge being sought not readily deducible by a competent professional?

Therefore, the two criteria most key in determining whether an innovative company is eligible for R&D tax credits are ‘advancement’ and ‘uncertainty’.

Allowable expenditure

If your company and the project both meet the necessary criteria, then it is possible to claim relief on expenditure in three main areas:

– staff costs (salary, employers NIC, pension contributions, etc.), subcontractors/freelancers
– consumable items, such as dedicated heat, light & power, materials
– equipment ‘used’ and/or ‘transformed’ by R&D process

Qualifying for R&D Tax Credits

If your company is taking a risk by innovating, improving or developing a process, product or service, then you may well qualify.

We often find that R&D activities functions will be spread across numerous aspects of the organisation, with some individuals playing a far more active role.

We usually start by working with clients to identify the specific job roles within a business, and attributing a percentage of their time as qualifying R&D expenditure. It’s not only technicians that can qualify; often a percentage of the time of other staff such as the CEO or marketing director can be allocated, too.

What It Could Be Worth – SMEs

For SMEs, from 1 April 2012, the R&D tax claim enhancement (the enhanced deduction) was 225% of the qualifying R&D expenditure incurred, and from 1 April 2015 was increased to 230% of the qualifying expenditure. Therefore, where an SME incurs expenditure of £100,000 on qualifying R&D, it can deduct £230,000 when calculating its taxable profit, or loss, for corporation tax purposes. So the additional £130,000 would be an extra deduction from taxable profit and the corporation tax savings would be £26,000.

Where the company is loss-making, or claiming the additional deduction makes it loss-making, the company can decide whether to carry back the loss to the previous accounting period (assuming there is a taxable profit), or to carry the loss forward and offset against future profits. Alternatively, and this is usually the case, the company can obtain a welcome injection of cash by giving up the losses now in return for a payable R&D tax credit from HMRC. So it’s a question of deciding whether you want “cake today or jam tomorrow”.

If the company elects to surrender its R&D enhanced loss to HM Revenue & Customs, in return for a cash credit, the cash credit can be worth as much as 33.35p for each £1 of the eligible R&D expenditure. This rate was 24.75p prior to 1 April 2014 and 32.63p for each £1 spent between 1 April 2014 and 31 March 2015.

What It Could Be Worth – Large Companies

For large companies, outside the SME definition, the rate of relief from HMRC is much lower, at approximately 6-9% compared to 25%-33% for SMEs, and before the Research & Development Expenditure Credit (RDEC) was introduced from 1 April 2013, large companies were not able to benefit from cash credits at all.

Some complicating factors to consider

There are various factors which can affect the size of any claim, and why you need our specialist advice to help you work through these issues.

• Subsidised expenditure: Where an SME receives a grant or subsidy, relating to an R&D project, then all or part of the SME’s qualifying R&D expenditure may not qualify under the SME scheme, although it may be treated as applying under the Large Company Scheme.

• Subcontracted R&D: If an SME carries out R&D subcontracted to it by a large company, then the SME can make a tax credit claim, but only under a Large Company scheme. If the SME sub-contracts some of its own R&D, then the amount of expenditure that can be claimed may be limited to 65%, depending on whether the sub-contractor is connected to the SME or not.

• Work carried out overseas: This can still qualify, subject to certain complicated rules.

Large Company scheme

The Large Company scheme operates as an enhanced deduction and is available until 31 March 2016. The rate of the enhancement is 30% (compared to that of 125% (130% from 1 April 2015) of the SME scheme). The enhancement will reduce the taxable profit of the company, but as no cash credit is available under the Large Company scheme, if losses are created or enhanced then these losses can only be carried back or forward as appropriate.

The RDEC scheme

The RDEC scheme is available for expenditure incurred on or after 1 April 2013. The key difference between the RDEC and the Large Company scheme is that the RDEC will allow a loss-making company to receive a payable tax credit.

For a company to be regarded as an SME (Small to Medium Enterprise) it must have a headcount of below 500 staff and meet at least one of the following; a turnover of below €100 million or gross assets of less than €86 million.

What Is a Large Company?

A company that exceeds any of the SME thresholds.