How do R&D tax credits work?
R&D tax credits are a tax relief designed to encourage greater R&D spending, leading in turn to greater investment in innovation. They work by either reducing a company’s liability to corporation tax or through a cash payment to the company.
The scheme allows companies to claim back up to 33% of the money they spent on research and development. It can even be claimed on unsuccessful projects.
In order for your company to claim their R&D costs, you will need to file an R&D claim with HMRC for the costs relating to the qualifying R&D projects, you can make claims going back 2 accounting periods.
The size of the R&D claim will depend on your total qualifying expenditure as well as the type of expenditure. Some will allow you to claim a higher percentage (employee costs) than others (subcontractor costs). Finally, some expenditures, such as rent, won’t qualify for R&D at all.
What R&D tax credit incentive is right for my business?
There are two type of R&D tax reliefs:
- The Small and Medium sized Enterprises R&D tax credit (SME R&D tax credit scheme). The SME R&D tax credits allow you to claim a higher rate of relief than a large company, up to 33% and you’re eligible only if you have less than 500 staff and a turnover of under €100m or a balance sheet total under €86m.
- The Research and Development Expenditure Credit (RDEC scheme) (also known as ‘Above-the-Line’). This scheme is designed for larger companies, or SMEs companies that are not eligible to apply for the SME R&D tax credit. The RDEC allows you to claim up to 13% of your company’s qualifying R&D expenditure (this rate applies to expenditure incurred on or after 1 April 2020).
Normally, SMEs that have spent money on research and development will claim the SME R&D tax credit, as this scheme is more generous than the RDEC (33% vs. 13%).
However, in the following circumstances, an SME will not be eligible to claim the SME R&D tax credit. In these cases the SME may still claim the RDEC:
- if they have been subcontracted to do R&D work by a large company.
- If they have received certain grants or subsidy for their R&D project.
- If they have more than 500 staff
- If they have a turnover over €100m or a balance sheet total over €86m
- if the project is already getting notifiable state aid
What qualifies for the R&D tax credit?
First and foremost, any company participating in any kind of R&D (and R&D is a very broad definition, far from being only software or deep tech) is very likely eligible for claiming back up to 33% of your expenditure on R&D in the form of corporation tax deduction or cash payments from HMRC.
To qualify the company must be carrying out R&D work in the field of science or technology. The relief is not just for ‘white coat’ scientific research but also for ‘brown coat’ development work in design and engineering that involves overcoming difficult technological problems.
The qualified R&D work must be part of a specific project to make an advance in science or technology. It cannot be in a theoretical field – such as pure maths.
The project must be clearly related to your company’s trade – either an existing one, or one that you intend to start based on the results of the R&D.
There are a few elements you’ll need to demonstrate in your R&D claim to show how your project:
- looked for an advance in science and technology
- had to overcome uncertainty
- tried to overcome this uncertainty
- could not be easily worked out by a competent professional in the field
What costs qualify for R&D relief?
Direct R&D staff costs
You can claim for Gross Salaries, Employer NI Contributions and Employer Pension Contributions for your PAYE employees engaged in your R&D project. This covers employees who undertake ‘hands on’ R&D work and the proportion of supervisory and managerial time spent specifically directing such employees in those activities.
Support staff costs, for example administrative or clerical staff, do not qualify, except when they relate to qualifying indirect activities. These can be activities like maintenance, clerical, administrative and security work.
Externally provided R&D staff
You can usually claim up to 65% of the payments made to the staff provider, in a case where your staff costs are paid to an external agency. Here as well, the eligible costs are for staff who are engaged in the R&D project.
- SME Scheme: You can generally claim for up to 65% of the payments made to subcontractors. The subcontracted work may be further subcontracted to any third party.
- RDEC Scheme: R&D expenditure subcontracted to other persons is generally not allowable unless it is directly undertaken by a charity, higher education institute, scientific research organisation or health service body — or by an individual or a partnership of individuals.
You can claim for the cost of items that are directly employed and consumed in qualifying R&D
projects. These include materials and the proportion of water, fuel and power consumed in the R&D process. Costs of materials incorporated in products that are sold are not eligible for relief.
You can claim for the cost of software that is directly employed in the R&D activity. Where software is only partly employed in direct R&D, an appropriate apportionment should be made.
If you are creating a prototype to test the R&D being undertaken, the design, construction and testing costs will normally be qualifying expenses. However, if the prototype is also built with a view to selling the prototype itself (such as the construction of a bespoke machine), this will be considered as a production and outside the R&D scheme.
In that case you need to work out the split between R&D expenditure and production costs. For example, the construction costs and materials consumed would not be qualifying expenses, but design, modelling and testing costs could still qualify.
Clinical trial volunteers
Pharmaceutical companies and research organisations often make payments to volunteers taking part in clinical trials.
What costs do not qualify?
Things such as: production and distribution of goods and services, capital expenditure under either of the R&D relief schemes, the cost of land and payments related to the creation of patents (including the staff costs in relation to the time spent by all staff on the
preparation and submission of such applications). However, with regards to patents, the Patent Box enables companies to apply a 10 per cent rate of Corporation tax to profits earned from their patented inventions after 1 April 2013.
Who qualifies for the R&D tax credit?
To be eligible for R&D tax relief, your company must have worked on R&D projects, incurred qualifying R&D expenses in the last 2 financial periods and be based in the UK. Based on the size of your business, you can claim R&D Tax Credits under the SME scheme or the RDEC scheme.
Almost all startups and SMEs will claim R&D tax relief under the SME scheme. To be eligible under this scheme, your company must have:
- staff headcount below 500
- either turnover of less than €100 million (£89 million approx.) or balance sheet total less than €86 million (£76 million approx.)
If you do not qualify for R&D tax credits under the SME scheme, you may be eligible under the RDEC scheme. Larger companies who are undertaking eligible R&D activities can claim cash payments if they are loss making or a deduction in their corporation tax liability if they are profit making. SMEs that are not eligible under the SME scheme because they have already received grants or subsidies for their R&D activity or have been subcontracted by larger companies to do R&D activities may also be able to claim under the RDEC scheme. However, this scheme is not as generous as the SME scheme and you can only claim back up to 13% of your qualifying R&D expenditure.
Your company does not have to belong to a specific sector to be able to claim R&D tax credits. R&D tax relief has been claimed by companies in industries ranging from manufacturing, Information and Communication, and Professional, Scientific and Technical sectors to agriculture, finance and insurance. So if you feel like you’ve been working on creating something unique and new to your industry, your project would most likely be an R&D project and be eligible for R&D Tax Credits.
While you may start the R&D application earlier, you will have to wait for your first financial year to submit it.
If you still haven’t completed your first financial period and want assurance on your next 3 claims from HMRC, start your R&D Advance Assurance application today!
How do you calculate the R&D tax credit?
Companies are able to claim up to 33% of their R&D expenditure back through R&D tax credits. However, this amount could differ if the company makes profits. Follow these steps to calculate your estimated R&D tax credits amount:
Calculate the total eligible R&D costs
Based on the R&D activities that you are undertaking, calculate the total of all eligible R&D expenditure. This would include wages (Salaries, Employer National Insurance and Employer Pension Contributions), subcontractors, consumables, software costs and costs of prototypes.
Calculate the uplift on the tax allowable R&D Expenditure
To calculate the uplift on allowable R&D Expenditure, multiply the total of all eligible R&D expenditure by 230% to get the ‘enhanced expenditure’ amount. This is the figure on which the value of your R&D payable tax credits (or tax relief) will be calculated.
Calculate the value of the R&D tax relief
This step will differ based on whether the company is making a profit or loss-
Profit Making company
In the case your company is profit making, you will receive R&D tax relief in the form of a reduction in your Corporation Tax liability of around 25% of your R&D expenditure. To calculate the value of your reduced Corporation Tax liability, subtract the ‘enhanced expenditure’ amount from Net Profits before Tax to get the Adjusted Profit before Tax. Multiply the adjusted Profit before tax by 19% to get your reduced Corporation Tax liability amount.
Loss Making company
In the case of your company being loss making, you will receive payable tax credits in the form of cashback from HMRC which will be up to 33% of your eligible R&D expenditure. To calculate the value of your R&D tax credits, simply multiply the ‘enhanced expenditure’ (230% of your R&D spend) amount by 14.5%. The resulting value will be the value of your payable R&D tax credits.
How do I claim R&D tax relief?
R&D tax credits are claimed through your Company Tax Return (CT600) which is normally submitted on an annual basis and based on the figures from your Statutory Company Accounts.
There are two components of an R&D claim and they are submitted as appendices to the Company Tax Return.
Your Technical Narrative is a document that has two main purposes. First of all it is used to justify why the work done by the company qualifies for R&D tax relief. It should outline the work done by the company, which technical uncertainties were encountered and how you attempted to overcome them. You do not need to be successful in overcoming these uncertainties to qualify for R&D tax relief, an aborted project or work done before a change in direction will still qualify.
Secondly it is used to justify the size of your claim by outlining the number of projects that took place in the period, the amount of time spent on those projects (employees or contractors) and any other expenditure that may be relevant.
This is a breakdown of costs and the percentage of those costs that relate to R&D. It should include any qualifying costs relating to employment (Salaries, Employer National Insurance and Employer Pension Contributions), contractors, software, consumables, prototypes and any other relevant expenditure. These figures are then used to calculate and show the uplift on your tax allowable R&D expenditure and the size of the tax credit or tax saving.
How far back can you claim R&D tax credits?
R&D relief must be claimed within 2 years of the accounting period the R&D took place. For example if your accounting year end is 31 December 2019 you have until 31 December 2021 to submit your claim. This means you are able to submit an amended tax return for a previous period if you may have missed out on potential tax credits or tax savings.
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