Whatever sector your business lies in, any innovation or new commercial technology that you produce will not only drive growth and help your business make a name for itself, but it could also make you eligible for research and development tax credits. Introduced as an incentive for businesses to produce innovative products and push technological advancements, R&D tax relief could help your business, giving you the financial incentive to take your technology further and aid future growth. Read our in-depth guide to research and development tax relief for a better understanding of whether you qualify and how it could help you.
Today we’ll be covering:
- What is research and development tax credit?
- What is the small or medium-sized (SME) R&D relief?
- What is considered research and development for the purposes of tax relief?
- What qualifies for research and development tax credit?
- How much can a company save through R&D relief?
- When does R&D activity start and end?
- How to claim research and development tax credit
- What is the difference between R&D relief and R&D Expenditure Credit (RDEC) scheme?
- Which R&D tax scheme is right for my business?
What is research and development tax credit?
Research and development (R&D) tax credits are a government incentive to reward companies for investing in innovation. Under R&D tax credits, companies that invest in new products and services are eligible to offset extra profit against these expenses.
There are two key tax incentives for revenue expenditure on research and development for companies. They are:
Companies may also be able to claim R&D capital allowances for any capital expenditure they may have on R&D. It is worth noting that the R&D relief is only available to companies and not to partnerships or individuals.
What is the small or medium-sized (SME) R&D relief?
Small or medium-sized enterprises (SMEs) may apply for R&D tax relief if the company has:
- Fewer than 500 employees
- A turnover of less than €100 million or a balance sheet total of under €86 million
An SME may need to include the figures of connected companies and partner companies when working out if they’re an SME. Having external investors can also impact whether a company is considered an SME. You cannot claim SME R&D relief if the project is already receiving notifiable state aid or you have been subcontracted by another company.
The staff, turnover and balance sheets of connected companies should be included in your total if your company:
- Holds over 50% of the voting rights in another company
- Another company holds over 50% of the voting rights in your company
A company is considered to have a partner company if:
- Another company holds over 25% of a company’s voting rights or capital
- If you hold over 25% of another company’s voting rights or capital
What is considered research and development for the purposes of tax relief?
What is considered research and development partly depends on whether a company has adopted UK GAAP or IAS for its accounting standards.
For companies using UK GAAP, development is defined under FRS 102 as:
'The application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.'
- The design, construction and testing of prototypes and models
- The design, construction and operation of a pilot plant
- The design, construction and testing of improved materials, devices, products, processes, systems or services
- The design of tools, jigs, moulds and dies
For companies using IAS, research is defined under IAS 38 as:
'The application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services prior to the commencement of commercial production or use.
The R&D activities are also required to relate to a project which represents an advance in science or technology and it is not sufficient for a company to believe the products are innovative or cutting edge.
According to HMRC’s R&D guidelines, science is the systematic study of the physical and material universe. Work in the arts, humanities, social sciences (including economics) and mathematics are not covered.
What qualifies for research and development tax credit?
Qualifying expenditure for research and development tax credit include employee costs, subcontractor costs, software, consumable items and clinical trial volunteers.
Employee costs include:
- Class 1 National Insurance contributions
- Pension fund contributions
You can also claim for administrative or support staff who work directly to support a project. For example, HR used to recruit a specific person to work on a project but you cannot claim for clerical work that would be done anyway.
Companies can claim 65% of payments made to external agencies and to subcontractors.
Companies may also claim for software licence fees bought for R&D and a reasonable share of the costs of software partly used for R&D activities.
The following costs are excluded from R&D relief:
- Capital Expenditure
- Cost of land
- Cost of patents and trademarks
- Cost of production and distribution of goods and services
- Rent or rates
- Capital Expenditure
How much can a company save through R&D relief?
Companies can save an additional 130% over the cost of their R&D efforts. SME R&D tax relief allows companies to:
- Deduct a total of 230% of a qualifying costs from their yearly profit (an extra 130% of over the normal 100% deduction)
- Claim tax credit (if the company is lose making) of up to 14.5%
Companies making their first R&D claims can qualify for advance assurance. If granted, advance assurance means that claims in the first three accounting periods will be accepted if they’re in line with what was discussed.
When does R&D activity start and end?
R&D activity starts when you begin working to resolve the uncertainty. A company must first identify the technical issues that need to be resolved and make sure there is not an existing solution.
R&D activity ends when you solve the uncertainty or stop working on it. You should stop claiming R&D relief when you have a working prototype that solves the problem and certainly before you go into production.
R&D relief may restart if you find another scientific or technical uncertainty after you have started producing the product.
How to claim research and development tax credit
You can claim R&D relief for up to 2 years after the end of the accounting period it relates to. R&D relief is claimed by entering the enhanced expenditure into your full company tax return form (CT600).
To calculate your enhanced expenditure, you need to:
- Work out the costs attributable to R&D
- Reduce subcontractor or external staff by 65%
- Add costs together
- Multiply the figure by 130% to get the additional deduction
- Adding the additional deduction to the original R&D expenditure figure
If you make a trading loss, you can choose to surrender this and claim tax credit.
Companies should provide a short summary explaining how the project advances science or technology and how it is new or innovative.
For companies claiming for 4 or more projects, you must include detailed descriptions on at least three to a maximum of ten projects which between them cover 50% of your total qualifying R&D costs.
What is the difference between R&D relief and R&D Expenditure Credit (RDEC) scheme?
R&D relief is only available to SMEs. Large companies, and those not meeting the definition of SME, are not eligible to claim R&D relief. Large companies may, however, be able to claim under the RDEC scheme instead.
The RDEC tax credit is worth 13% of your qualifying R&D expenditure. The credit is taxable at the normal Corporation Tax rate (19%) and is visible income in a company’s accounts. Because the RDEC rate is paid net of Corporation Tax, a company can expect to receive 11p for every £1 of qualifying R&D.
A number of the restrictions that apply to R&D relief do not apply to the RDEC. For example, there is no requirement that a large company actually owns the intellectual property to which the R&D relates. R&D expenditure credit is also available to SMEs for qualifying expenditures which do not qualify for SME relief because it exceeds the cap on the relief or is R&D subcontracted by a large company.
Which R&D tax scheme is right for my business?
The SME R&D tax relief offers a more generous tax credit rate than the RDEC. It is, therefore, normally advisable for a company to claim R&D tax relief rather than RDEC, if you can. However, in certain circumstances SMEs are prevented from using R&D tax relief and may therefore claim through the RDEC scheme instead.
Large companies are ineligible for SME R&D tax relief and should claim RDEC.