R&D tax credits are a form of tax relief offered as part of a government scheme to boost innovation in the UK.
If your company has spent money developing a new product or service, or significantly improved one that already exists, you might be able to claim back up to 33% of your research and development costs.
R&D tax credits are a tax relief designed to encourage greater R&D spending in the UK. They can be a phenomenal source of cash flow, and the good news is that they’re not going anywhere anytime soon. The government has emphasised how central advancements in science, research and innovation are to the UK economy, announcing its intention to increase UK investment in R&D to 2.4% of GDP by 2028 and to increase public funding for R&D to £22 billion a year by 2024/2025 (source: gov.uk).
R&D tax credits work by either reducing a company’s Corporation Tax bill or as a direct cash payment to the company.
The scheme allows companies to claim back up to 33% of the money they spent on research and development. And even better, it can be claimed on unsuccessful projects too.
To claim R&D costs, you’ll need to file an R&D claim with HMRC detailing the amount you spent on R&D-qualifying projects. You’ll submit this claim at the same time as you file your Corporation Tax return. You can claim R&D tax relief retrospectively for the previous two accounting periods.
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 two financial periods and be based in the UK.
The size of your R&D cashback will depend on your total qualifying expenditure as well as what exactly you spent the money on. You can claim more for some activities (employee salaries) than others (subcontractor fees). Some types of expenditure, like rent, won’t qualify for R&D at all.
What type of R&D tax credit incentive is my business eligible for?
There are two types of R&D schemes available to UK businesses: SME and RDEC. Which one you qualify for mainly depends on the size of your business.
The SME R&D tax relief scheme
For small and medium-sized businesses
With less than 500 staff
And a turnover of under €100M (about £85M) or a balance sheet total under €86M (about £73M)
You can claim a higher rate of tax relief than a larger company – up to 33%
Most SMEs will claim the SME R&D tax credit because it’s more generous than the RDEC - a top rate of 33% vs 10.53%.
There are some circumstances, however, that disqualify an SME from claiming the higher rate of tax relief. These SMEs can still claim tax relief but under the RDEC scheme instead.
SMEs are disqualified from the SME R&D tax credit scheme if:
- they have been subcontracted to do R&D work by a large company
- they have received certain grants or subsidies for their R&D project
- the project is already getting state aid
The RDEC scheme (Research and Development Expenditure Credit)
For larger companies with over 500 staff and a turnover of over €100M or balance sheet total of €86M
And SMEs that don’t qualify for SME R&D tax credits (due to grant funding, for example)
You can claim up to 10.53% of your company’s qualifying R&D expenditure
What are the rates of R&D tax relief?
How much of your expenditure you can claim back as R&D tax credits depends on whether you’re claiming under the SME or the RDEC scheme. For the SME scheme, it also makes a difference whether you’re profitable or not.
If you qualify for the SME scheme, you can claim up to 33% of your qualifying R&D expenses back from HMRC if you are loss-making. However, if you are profitable, you can get a reduction in your Corporation Tax liability of around 25% of your R&D expenditure.
If you are claiming R&D under the RDEC scheme, you can only claim up to 10.53% of your qualifying R&D expenses.
See below for a table of the maximum rate you can claim in R&D tax relief.
What kinds of projects qualify for the R&D tax credit?
R&D actually has a very broad definition. It’s not just software development or life science companies who are eligible for R&D relief.
To get R&D tax credits, you need to show your company took a risk by investing money in trying to resolve a scientific or technological uncertainty. The idea is that you should be rewarded for trying to advance scientific or technological knowledge and capabilities – no matter which sector your company is in.
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 scheme’s definition of R&D is intentionally broad so that it covers activities in as many industries as possible.
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.
We’ve looked at the type of projects that HMRC considers R&D. Now let’s go into the kinds of costs you can claim back as an R&D expense. Salaries and other staff costs usually make up the bulk of R&D claims.
Direct R&D staff costs
You can claim for gross salaries, employer National Insurance contributions and employer pension contributions for your PAYE employees who were involved in your R&D project. This covers both the employees who did the hands-on R&D work as well as the time spent supervising and managing those employees as they carried out their work.
Qualifying Indirect Activities (QIA)
Support staff costs, like administrative or clerical staff, do not usually qualify unless you can show individuals performed indirect activities that supported the R&D project. This could include clerical work like note-taking at R&D project meetings, cleaning and maintaining equipment or security related to the R&D project.
Externally Provided Workers (EPWs)
You can usually claim up to 65% of the payments made to the external agency for temporary staff hired to work on the R&D project.
Under the SME scheme, you can generally claim up to 65% of the payments made to subcontractors.
Under the RDEC scheme, you generally can’t claim back subcontractor costs. The exception to this is when the work is directly undertaken by an individual, a partnership of individuals, a charity, higher education institute, scientific research organisation or health service body. In these cases, you can usually include up to 100% of your expenditure in your RDEC claim.
From April 2023, you will no longer be able to claim for subcontractors based outside of the UK. See more 2023 updates
You can claim for the cost of materials used up in the course of your R&D project. This includes the cost of materials, water, fuel and power. However, you can’t claim for the costs of materials used to build the actual products that you sell.
You can claim for the cost of software that is directly used in your R&D activity. If you use the software elsewhere in your business as well as for your R&D activity, you can only claim a proportion of the cost.
If you are creating a prototype to test the results of your R&D, the design, construction and testing costs will normally be qualifying expenses. However, if you’re planning to sell the prototype itself, this counts as a production cost and is outside the R&D scheme.
It can be tricky to separate the split between what is R&D expenditure and what is production cost. To talk through how to classify your project spends in your claim, book a call with an R&D specialist.
Clinical trial volunteers
Pharmaceutical companies and research organisations often make payments to volunteers taking part in clinical trials. You can claim this back as an R&D expense.
What expenses don’t qualify for R&D tax credits?
R&D tax credits are a financial incentive for companies to spend money on activities that lead to advancements in science and technology.
As such, they’re not designed to support companies beyond the discovery and experimentation stage. That means that you can’t claim for costs incurred in the production or distribution of goods or services your company creates off the back of your R&D work. You also can’t claim for rent or land.
Perhaps surprisingly, you also can’t claim any costs related to the creation of patents, including for the time spent by staff on preparing and submitting patent applications.
However, there’s another HMRC tax relief scheme called Patent Box which gives eligible companies a 10% Corporation Tax break on profits earned on patented inventions.
How do you calculate R&D tax credit?
Now you know what kinds of projects and costs are eligible for R&D tax relief, it’s time to get into the maths behind how your tax credits are calculated.
This includes your staff costs (salaries, employer National Insurance and employer pension contributions, bonuses and reimbursed expenses), EPWs and subcontractors, materials and software costs.
Tax credits under the SME scheme
Calculate your R&D ‘enhanced expenditure’
All companies can deduct 100% of eligible R&D costs from their tax liabilities. Companies that qualify for the SME scheme get an additional 130% – this is called the ‘uplift’.
When you add this 130% uplift to the default 100%, you get the ‘enhanced expenditure’ amount of 230%. Multiply your total eligible R&D expenditure by 230%.
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 depends on whether your company is making a profit or loss:
For a profit-making company
If your company is making a profit, you will receive R&D tax relief in the form of either a reduction or a refund of your Corporation Tax bill. This reduction will be around 25% of your R&D expenditure.
To calculate the value of your reduced Corporation Tax liability, subtract the enhanced expenditure amount from your net profits before tax to get your adjusted profit before tax. Then multiply the adjusted profit before tax by 19% to get your final, reduced Corporation Tax bill.
For a loss-making company
If your company is loss-making, you’ll receive tax credits in the form of cashback from HMRC. This could be up to 33% of your eligible R&D expenditure.
However, as a loss-making company you’ll have to make a strategic choice about whether you want to ‘surrender the loss’ for your current financial period.
You can choose to carry forward your loss to offset your tax bill for a future profitable period. If you’re confident you will soon be making money, it might make financial sense to carry forward your loss for a potential greater return later (depending on how much loss you have), instead of taking the cash credit now. You also have the option to carry losses backwards if you have trading profits in prior years.
If you decide you’d rather have the cash now, you’ll be ‘surrendering the loss’. It’s called surrendering because you won’t be able to use it later to reduce your Corporation Tax liability. If you decide to surrender, your cash credit is calculated by applying a rate of 14.5% to your enhanced expenditure figure.
Here’s a closer look at the maths.
Say you have £100,000 of eligible R&D spend.
£100,000 x 230% = £230,000. This is your enhanced expenditure.
£230,000 x 14.5% = £33,350. This is the cash credit you receive.
£33,350 / £100,000 = 33%. You receive 33% back of your R&D spend.
The amount you can claim back as a cash credit might be limited by how much you’ve spent in the period on payroll staff. The cap for SMEs is calculated as 300% of total PAYE and NIC liabilities, plus £20,000.
Tax relief under the RDEC scheme
The RDEC rate of tax relief is a flat 13%. However, the amount of tax credit you can actually claim is lower, because it takes into account the rate of Corporation Tax (currently 19%). This means that the ‘effective tax benefit’ you can claim is 10.53% of your total R&D spend.
Say you had £100,000 of qualifying R&D spend. Multiply that by the 13% RDEC rate to get £13,000. You then take off the tax rate at 19% and are left with your RDEC tax relief amount of £10,530.
So, while the official RDEC rate is 13%, the effective tax benefit you can claim under RDEC is 10.53%.
The amount you can claim back as a cash credit might be limited by how much you’ve spent in the period on PAYE and NIC. For companies claiming under the RDEC scheme, the amount of credit you receive cannot be higher than your PAYE and NIC liabilities during the period.
How do you 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.
To claim R&D tax credits, you’ll need to submit the CT600 and your Technical Narrative.
A CT600 form is part of a Company Tax Return and includes information regarding your itemised taxable profits or losses for a given period. Your accounting period for Corporation Tax is generally the same as your financial year but will never be longer than 12 months.
Your Technical Narrative is where you explain to HMRC why your work qualifies as R&D.
It should outline the work done by your 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.
You also need 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.
How far back can you claim R&D tax credits?
You can claim R&D tax relief retroactively for the previous two accounting periods. For example, if your accounting year end is 31 December 2022, you have until 31 December 2024 to submit your claim.
This means you can submit an amended tax return for a previous period if you have missed out on potential tax credits or tax savings.
When should you submit your R&D tax credit claim?
Bear in mind that many companies have December as the end of their financial year. This means there’s a rush to pay Corporation Tax bills at the end of September. If you submit your claim during HMRC’s busy period between September and December, you might be waiting a long time to get your application and payment processed.
In general, we suggest that you submit your claim before September to take advantage of shorter turnaround times.
What’s the average HMRC processing time for R&D claims?
HMRC have recently increased their standard processing times for R&D claims – from 28 days to 40 days.
This rise in average turnaround times makes it all the more important to submit your R&D tax credit claim early. At SeedLegals, we make it quick and easy to submit an accurate and comprehensive claim. See how we can help you submit faster.
How are R&D tax credits changing in 2023?
There’s a shakeup coming for R&D claimants in 2023.
Certain changes in tax legislation will come into effect from April 2023. The most important updates that relate to R&D are:
R&D activity will have to take place in the UK. From April, subcontractors and EPWs must be based in the UK to count as an eligible expense
Costs related to cloud computing and data storage will now be eligible
The rate of Corporation Tax dependent on profit before tax will rise from 19% to 25%
How can SeedLegals help you with your R&D tax credits claim?
It might seem complicated to submit an R&D tax credit claim, considering all the data gathering and narrative crafting.
But when you claim your R&D tax credits through SeedLegals, you have the benefit of a dedicated tax specialist to help you out. We’re much cheaper than an accountant and have a 100% success rate (as of June 2022) with 0 claims reduced by HMRC.
Create your Technical Narrative. Follow our online guidance to write your narrative. We prompt you to include information about advances, technical uncertainties and resolutions, and to describe the people involved in your projects. Our R&D experts are on hand to help.
Enter your totals. Fill in the total amounts you’ve spent for the categories of eligible costs, such as employees’ salaries and payments to subcontractors.
Upload your company accounts. When you’ve uploaded your most recent company accounts, all the data for your claim is stored securely on our platform.
Submit your claim for review. Our R&D experts thoroughly review your claim. We don’t just check it’s 100% correct, we’ll work to maximise what you get back.
Send to HMRC. When we’ve completed our review, submit your claim to HMRC.
Swap R&D for some R&R – chat with us today to see how we can speed up your tax credit claim.
Talk to the R&D experts
Still unsure if your costs qualify or how to write your Technical Narrative? Book a call with one of our experts, and we’d be happy to answer any questions you have.