Research and Development (R&D) tax credits are a valuable source of tax benefit for many businesses in the UK. The scheme has been designed to help encourage innovation through offering assistance in funding the development of new products, services and processes that can improve efficiency.
Although R&D tax credits have been around for the last two decades, many businesses are still not aware of them and that they may be eligible for this valuable tax benefit. Over 50,000 businesses claim R&D tax credits, but it is estimated that many more could benefit from the tax relief. It has been estimated that only 20% of eligible businesses make an R&D tax credit claim which is attributed to a lack of knowledge of the scheme, misunderstanding of who is eligible for it, the complexity of claiming this tax benefit and the lack of knowledge on the level of tax relief available to businesses.
What is R&D tax credits?
The R&D tax credit schemes are a government initiative that was first created in 2000 but they have evolved over the years since and been refined. They have been designed to provide tax relief for businesses who are investing in research and development that can benefit more than just the business itself.
The R&D tax credit schemes were set up to encourage research and development activity in businesses in the UK by offering them an attractive tax relief benefit which rewards them for their investment.
R&D tax credits work by reducing the business’ tax liability by adding a credit to the business’ tax account or paying out a cash amount. There is a variety of eligibility criteria for R&D tax credits, but the key initial eligibility factor is that the business must be registered to pay Corporation Tax. The level of tax relief that you can receive varies and it is directly based on the amount of qualifying R&D expenditure that the business has made during the tax year that it is applying for relief on.
What are the two types of R&D tax credits?
R&D tax credits consist of two distinct schemes which cater for different sizes of business. The two schemes are:
- An SME scheme which is designed for small or medium enterprises.
- A Research and Development Expenditure Credits (RDEC) which caters for larger businesses or those businesses that form part of a larger concern.
The SME scheme is designed for small or medium-sized enterprises who have under 500 employees and a turnover below €100 million or a balance sheet below €86 million. Under the SME scheme, the business can claim a higher rate of relief than larger companies through the RDEC scheme, although RDEC claims tend to be for large amounts.
THE RDEC scheme is designed for larger businesses that have more than 500 employees and have a turnover above €100 million or a balance sheet over €86 million in line with the SME scheme. Although there is also an except where SMEs who are subcontracted by larger businesses they can apply through the RDEC scheme rather than the SME scheme.
How much are R&D tax credits worth?
Based on the data from the R&D tax credit claims for the financial year 2018-19 the average SME R&D tax credit claim was £57,228 and the average RDEC tax credit claim was £332,160.
The amount that you can receive varies depending on the activity and the level of expenditure. However, businesses can expect to claim up to 33% tax relief on qualifying R&D expenditure through the SME R&D tax credit scheme. Through the RDEC R&D tax credit scheme, businesses can expect to receive over 10% tax relief for qualifying R&D spend.
Could your business be eligible?
If your business is registered to pay Corporation Tax and has undertaken activity that can be deemed as R&D then you could be eligible. The key factor that determines whether an activity is eligible for R&D tax credits is the activity has to be seen as technically challenging or innovative within your industry. It must be viewed as being progressive within the industry but not necessarily in the wide business landscape. HRMC will expect you to be able to demonstrate this challenge or innovation by showing how the advancement was identified, investigated and realised. You will also need to demonstrate that has a wider benefit than for just your business.
When making a claim it is important to understand what the HMRC are looking for in the claims and what they really want to see is that there was a level of uncertainty about whether the advancement was possible before the research and development was undertaken. They will want you to show how you had to undergo research, testing and analysis in your development of the advancement or innovation. This will need to be presented to them clearly with supporting evidence.
It is worth noting that R&D projects that were deemed unsuccessful but were conducted thoroughly and meet the criteria may also be eligible for R&D tax credits as the business did put effort and money behind the R&D activity despite the outcome.
There are no restrictions on the types of industries that can apply for R&D tax credits. To help you understand the types of businesses that apply for R&D tax credits we have listed below the sectors that make claims in order of the number of claims received in 2018-19:
- Information and communication
- Professional, scientific and technical
- Wholesale, retail trade and repairs
- Admin and support services
- Other services activities
- Financial and insurance
- Health and social work
- Arts, entertainment and recreation
- Agriculture, forestry and fishing
- Transport and storage
- Water, sewage and waste
- Accommodation and food
- Real estate
- Electricity, gas, steam and air conditioning
- Mining and quarrying
- Public admin, defence and social services
Can loss-making businesses claim R&D tax credits?
Businesses that are making a loss can still claim R&D tax credits even though they may not have Corporate Tax liability. As the rules on receiving the tax benefit allow businesses to claim the relief in different ways including cash rebate, cash credit, loss relief or future Corporation Tax savings it means it is possible.
Can subcontractors claim R&D tax credits?
Subcontractors can be eligible for R&D tax credits especially if they are leading the development of a new product or process. For example, if you are asked to adapt a product that you supply to a client to meet their needs but are not told how to do it, you could be eligible as you are completing your own research and development to make the adaptation.
How do you claim R&D tax credits?
R&D tax credit claims can be completed on your full Company Tax Return form (CT600) by completing the enhanced expenditure and the online service (gov.uk) can be used to submit supporting documentation for your claim. This process applies for both the SME and RDEC R&D tax credit schemes. The next section explains how you calculate the enhanced expenditure.
It is advisable to include a short summary of the claim which clearly explains and highlights the advancement made, what uncertainty was identified and how this uncertainty was investigated and overcome, and why this could not be easily done by anyone in the field.
Your claim will need to show which accounting period the claim is for and how the R&D activity also fits within this period, your business’ unique tax reference number, the total relief amount being claimed, a breakdown of your qualifying R&D costs and any trading losses if applicable.
Loss-making businesses can alternatively make a claim for a tax credit through converting the tax relief into a cash payment. This needs to be completed on the Corporate Intangibles R&D Manual.
How to calculate your R&D expenditure
You will need to calculate your qualifying R&D expenditure by working out the costs that are directly attributable to the R&D activity undertaken within the accounting period being claimed.
Subcontractor or external staff provider costs will need to be reduced to 65% of the original cost. The total costs then need to be multiplied by 130% to calculate the additional deduction for the tax calculations and this needs adding to the original R&D expenditure figure to get your enhanced expenditure amount which you will need add onto your tax return.
What costs can you claim for?
There is a wide range of qualifying expenses which can include:
- Employee salaries
- Employer’s National Insurance contributions
- Employer’s pension contributions
- Expenditure made on subcontractors or externally provided workers
- The cost of materials or consumables related to R&D activity which can include heat, light and power
- The purchasing of some software or software licenses
- If you conduct clinical trials you can include payments to participants
- If you pay contributions to other organisations for research you can claim for these under the RDEC scheme
Note this is not an exhaustive list but an example of some of the things that could be eligible depending on your R&D activity.
However, some costs cannot be claimed which include:
- Production and distribution costs of goods and services
- Any capital expenditure costs
- Any rent or rates the business incurs
- The purchase of land
- Any costs relating to trademarks or patents
When are the R&D tax credit deadlines?
R&D tax credit claims can be made based on your business’ accounting year and can be claimed after the end of that accounting year. There is also an allowance to let businesses to claim previous accounting years for up to two years after that accounting period ends.
How are R&D tax credits paid?
It will depend on your business’ circumstances on how your R&D tax relief will be paid. Primarily the preferred route by HMRC is that if your business has a Corporation Tax liability to pay, the tax relief will be deducted from this liability, so you have less tax to pay.
If your business doesn’t have a Corporation Tax liability then you can either get a cash payment or get a reduction in your next tax payment.
If you are a loss-making business it is also possible to get a cash rebate or cash credit. These businesses could also make a loss relief if you were previously profit-making so that you can carry your R&D losses to make a tax rebate or you can carry it forward to offset future profits. It is worth exploring which tax benefit option is the best for your business before choosing one.
What are the common misconceptions about R&D tax credits?
The R&D tax credit scheme eligibility is probably one of the biggest misconceptions as many businesses do not deem themselves as doing research and development. This is largely because many only think of traditional R&D and believe it is only for scientific, research or technology-related businesses. When in fact it is open to all types of businesses regardless of size.
Many businesses feel that R&D tax credits are too complex or difficult and not worth the effort. With the average claims being £57,228 for SMEs and £332,160 for larger businesses claiming through the RDEC scheme it is worth the effort. And although it might not seem straight forward for most businesses to do themselves, there are many accountants or R&D tax credit specialists that can support you in making a claim.
Who can provide support to businesses claiming R&D tax credits?
As explained R&D tax credits are not entirely straight forward and there can be a lot of misconceptions about eligibility for them, what activity can be included and understanding the rules to make a claim. This is why there is support available to businesses to help them make claims.
HMRC provides guidance to help business which can be found here.
Many businesses seek the support of their accountant in making R&D tax credit claims but not all accountants are experienced in making claims and it might be worth engaging the services of a reputable R&D tax credit specialist.