General Understanding
Research and Development Tax Credit is government encourage companies to invest in research and development by offering additional tax relief on the actual expenditure incurred.
The scheme applies to UK companies subject to the corporation tax.
The primary concern revolves around determining the eligibility of their businesses for the R&D tax credit. Research and Development encompasses activities a business undertakes to gain a competitive edge over rivals. It encompasses any efforts a business makes to enhance a product, service, or process by addressing technical uncertainties.
Strategies for Maximising the R&D Tax Benefit
In the UK, you can get the most out of the R&D tax credit by making sure you meet the eligibility requirements and using certain strategies to make sure you get the most credit possible.
1. Identifying Eligible R&D activities.
Businesses believe R&D is only about inventing a new drug or machine or artificial intelligence and is available for pharmaceuticals or manufacturing or IT businesses. But R&D has quite a broad scope.
It covers any innovative attempt to enhance a system or service or product. A range of businesses can claim R&D. Below are just examples and not an exhaustive list:
- farming business intending to grow new hybrid crops which are healthier than existing ones.
- manufacturers intending to design more convenient or cost-effective manufacturing techniques.
- breweries trying to innovate and improved brewing practices.
2. Documentation of your R&D projects thoroughly.
Keep meticulous records of all aspects of your R&D projects, including but not limited to project plans, technical specifications, design documents, test records, and any other pertinent information.
This documentation will help to support your claim and demonstrate that the activities you participated in are eligible.
3. Capture all eligible costs.
The legislation sets out specifically what expenditure qualifies for the relief. The costs include:
- Staffing cost
- Software
- Consumable items or transformable stores
- Externally provided workers
- Payments made as part of clinical trials
- Subcontracted R&D
- Contributions to independent research
To qualify for the relief, the expenditure must not be capital in nature.
4. Utilising the Pre-trading expenditure.
Importantly for many R&D companies, more expenditure is incurred before the trade has begun. For these companies, the expenditure is treated as occurring on the first day of the trade. This would prevent companies which undertake R&D in preparation for beginning to trade from claiming the R&D tax credit.
However, SME companies can accelerate the tax relief for their R&D expenditures and can even cash in any losses for the R&D tax credit.
Special rules are therefore included in the legislation which treats the pre-trading expenditure incurred by SME companies as though it creates a loss of the trade for the period in which the expenditure is incurred.
Please note that from 1 April 2023, the SME credit rate has been reduced from 14.5% to 10%
5. R&D Relief eligible on an unsuccessful project
The research and development work should not be done by accident but rather with a specific goal in mind.
However, the majority of the company is oblivious to the fact that the R&D claim can still be made even if the project for which the research was carried out is not successful.
The claim for research and development can be made regardless of the outcome of the project as long as the activity being claimed qualifies, and both the costs and the research and development itself can be claimed.
6. Joint Irrevocable agreement with Subcontractors.
As is the case for externally provided workers, the qualifying expenditure is 65% of the payments made to the subcontractor where the claimant company and the subcontractor are not connected.
To determine whether a subcontractor is connected, the UK tax legislation considers various factors such as control, ownership, and financial relationships between the subcontractor and the claiming company. Some common examples of connected subcontractors include subsidiaries, parent companies, and companies with common directors or significant shareholdings.
An election can be made jointly by the company and the subcontractor to be treated as though they were connected. This could be beneficial where the cost to the subcontractor is greater than 65% of the subcontracting payment.
A bit of a caveat is that this joint arrangement can be made for up to 2 years. Also, this election would require the subcontractor to disclose its profit margin to the principal, which is usually commercially sensitive. HMRC guidance CIRD84200
7. Collaborative Projects.
Participating in collaborative research and development projects with other companies can result in a number of benefits. Not only does it encourage innovation through the sharing of expertise, but it also gives you the opportunity to pool resources and potentially claim R&D tax credits for the projects that you work on together.
When two different businesses decide to conduct research and development (R&D) on the same topic, they might conclude that it would be beneficial for them to work together on it. In this scenario, both businesses would be required to contribute but would be free to reap the benefits of the R&D independently. Because this is cooperative research, each company might be able to receive R&D tax relief on its proportionate share of the total expenditures that qualify for the credit.
8. Be aware of the existing organisational structure.
There is a possibility that an SME may not qualify for the SME R&D Tax Credit but instead be eligible for the Research and Development Expenditure Credit (RDEC).
When an SME is part of a larger organization, it is necessary to assess the R&D Tax credit applicable to the SME by taking into account the books of the larger company. This evaluation may lead to the conclusion that the business qualifies for the RDEC scheme instead of the SME scheme.
Considering the company’s size is crucial in determining the available R&D Tax benefit and avoiding incorrect claims.
9. Utilisation of the Patent Box Regime
The Patent Box is meant to work with the R&D tax relief to encourage companies to keep their intellectual property in the UK after it has been developed.
The R&D relief does not cut into the benefit you get from Patent Box.
The Patent Box is helpful because it lets companies take an extra deduction on their tax returns. This means that profits from patents are taxed at a rate of 10%.
Even if the part of the product or process that is patented is small, the 10% Patent Box corporation tax relief should apply to all of the company’s worldwide profits from qualifying IP income.
Corporation Tax went from 19% to 25% on April 1, 2023, for companies that made more than £250,000. This made Patent Box more valuable.
The relief is given as an additional deduction in the corporation tax computation, rather than simply taxing the profit at the Patent Box rate.
The additional deduction is calculated as follows:
RP x ((MR-IPR)/MR)
Where:
RP = Relevant IP profit
MR = main rate corporation tax
IPR = Special IP rate of corporation tax i.e., 10%
Let’s understand this with an example.
XYZ Ltd had a patent related profit of £650,000 for the year ending 31 March 2024.
Without the Patent Box relief, the corporation tax would be £162,500 (taxed at 25%)
However, the corporation tax after the Patent box relief will be computed as follows:
Patent Box deduction:
£650,000 x ((25-10)/25)
£390,000
This will reduce the profit which will then be taxed at 25%
Profit £650,000
Less: Patent Box deduction £390,000
Revised Profit £260,000
Therefore, the corporation tax payable is £65,000 which is effective 10% of the Patent related profit.
10. Create an impressive technical narrative.
When submitting a claim for R&D tax relief in the UK, it is crucial to create an impressive technical narrative.
A technical narrative is a comprehensive and persuasive document that describes the R&D activities conducted, their technical challenges, and innovative solutions developed. It plays a crucial role in demonstrating the R&D project’s eligibility and defending the tax relief claim. An impressive technical narrative highlights the novelty, uncertainty, and technical complexities of the scientific or technological advancements made, highlighting their scientific or technological significance.
It helps HM Revenue and Customs (HMRC) reviewers comprehend the extent and significance of the R&D efforts, ensuring that the claim is supported by a clear and persuasive argument. A well-written technical narrative not only increases the likelihood of a successful claim, but also strengthens the credibility of the R&D project, providing a solid foundation for maximising the available tax relief benefits.
Final Insight
Finally, optimising your R&D tax benefit requires strategy and attention to detail. Documenting R&D activities, identifying eligible expenses, and using government incentives can help your company maximise tax benefits.
Be aware of current regulations, seek professional advice when needed, and keep accurate records to maximise R&D tax benefits. These strategies can optimise your financial position and foster innovation and growth in your company, ensuring long-term success in a competitive business environment.
