To encourage innovation and new technology among UK businesses, the government offers tax credits for Research and Development expenditures.
However, figuring out how much of a credit you are eligible for can be difficult. Here, we will walk you through the process of determining your UK R&D tax credit in detail.
Research and Development Tax Benefits
Depending on the size of your business and whether or not the project has been subcontracted to you, you may qualify for one of the following types of R&D tax relief.
The tax benefit varies if the company is Small and medium Sized Enterprise or Large company.
1. Small and Medium-Sized Enterprise (SME) R&D Tax Relief
When figuring out their total taxable profits, small and medium-sized businesses (SMEs) that make taxable profits can deduct an amount equal to an extra 86% of their qualifying R&D spending.
This rate was reduced from 130% to 86% from 1 April 2023.
For Example,
Tiny Limited has spent £95,000 on qualifying R&D in the accounting year ending 31 March 2024.
While calculating the taxable trading profit for 2023/24, the total R&D deduction available to Tiny Limited will be:
£95,000 x 186% = £176,700
This means that Tiny Limited can claim an extra deduction of £81,700 which will result in saving of the corporation tax of £20,425 (Assuming corporation tax at 25%).
2. Small and Medium-Sized Businesses (SME) R&D Tax Credits
On the other hand, the loss making small and medium-sized enterprises (SMEs) can ‘surrender’ a portion of their trading loss to the government in exchange for a tax refund.
The surrenderable amount will be the lower of:
- The unrelieved trading loss
– For the purposes of this definition, “unrelieved trading loss” refers to the trading loss of the period increased by additional R&D relief claimed minus any claims for relief for that loss in the current period and any other actual loss relief claims made in respect of the loss.The losses which have been brought forwarded or carried back to the accounting period is no considered while computing the unrelieved trading loss. - 186% of the qualifying R&D Expenditure (230% Prior to 1 April 2023)
The SME R&D Tax credit given will now be lower of:
- 10% of the surrenderable loss (14.5% prior to 1 April 2023)
- the PAYE cap on all employees, which is £20,000 + (3 x relevant expenditure on workers)
Relevant Expenditure on Workers
Company’s total liability for PAYE and Class 1 NICs for the period
any amounts for employees acting as externally provided workers or subcontractors on the R&D activities of connected companies.
PAYE and NICs paid by connected companies where they provide externally provided workers or subcontractors performing qualifying R&D for the claimant company.
However, PAYE cap will not be applicable to the following:
- Companies creating and managing intellectual property.
- Companies where qualifying expenditure on externally provided workers and subcontracted R&D by a connected company.
For Example,
ABC Ltd spends £125,000 on qualifying R&D in the year ending 31 March 2024. After R&D expenditure relief, the company has a trading loss of £335,000 and non-trading income of £40,000. £10,000 was owed in PAYE and NICs by the business.
The surrenderable loss is lower of:
Unrelieved trading loss: £335,000 less £40,000 = £295,000
186% of qualifying R&D Expenditure: 186% x £125,000 = £232,500 i.e., £232,500
The tax credit given will be £232,500 x 10% = £23,250 as this is lower than the cap of £50,000 (£20,000 + 3 x £10,000).
the PAYE cap will be after considering the payment made to all the staff irrespective of the fact that they are not involved in the R&D Project.
the PAYE cap will be in effect for accounting periods that start on or after April 1, 2021. When the accounting period is less than 12 months, the amount of £20,000 is proportionately reduced.
3. Research and Development Expenditure Credit (RDEC)
Large companies are those that do not qualify as SMEs according to the aforementioned criteria.
As per RDEC, the large companies, unlike SMEs, cannot claim additional expenses, but can request HMRC to pay them a certain percentage of R&D expense (or offset with corporation tax liability).
Relief must be claimed and is provided as a credit for R&D expenditures (RDEC). Claims must be included in the business’s tax return or an amendment to the return. Claims must be submitted within two years of the close of the applicable accounting period.
The RDEC is considered a taxable receipt when calculating the trade’s profits for the accounting period. The same amount will also be credited against the company’s tax liability.
20% (13% prior to 1 April 2023) of the company’s qualifying R&D expenditures comprise the RDEC.
For Example,
Large company incurred £300,000 on Research and Development during the year ending 31 March 2024. The total sales of the company during the year were £3 million with allowable expenses being £1 million.
The corporation tax payable will be computed as follows:
| Income | £3,000,000 | |
| Less: R&D expenditure | (£300,000) | |
| Add: RDEC (300,000 x 20%) | £60,000 | (£240,000) |
| Other deductible expenses | (£1,000,000) | |
| Taxable Trading Profit | £1,760,000 | |
| Corporation tax liability: £1,760,000 x 25% | £440,000 | |
| Less: RDEC (fully utilised) | (£60,000) | |
| Corporation tax payable | £380,000 |
The Research and Development Expenditure Credit (RDEC) will appear in tow places in the company’s tax return:
- RDEC is added to company’s taxable profit.
- RDEC is reduced from corporation tax payable.
If the corporation tax payable is insufficient to utilise the Research and Development Expenditure Credit (RDEC). The company will receive the cash repayment of the lower of the following:
- RDEC remaining after offsetting the tax liability.
- RDEC – (RDEC x 25%).
- PAYE and Class 1 NICs liability relating to the R&D staff.
Any RDEC still remaining after the cash repayment calculated above will be treated as a credit against the Corporation tax liability for the next accounting year.
For Example,
Assuming in Example 3 the trading loss of the company is £84,500 and the PAYE and Class 1 NICs liabilities relating to the staff working on qualifying R&D is £25,000, the cash repayment will be lower of the following:
£60,000
£60,000 – (£60,000 x 25%) i.e., £45,000
£25,000
Therefore, the cash repayment is £25,000.
The excess RDEC of £45,000 will be carried forwarded and treated as a credit for the next accounting year.
A major advantage as depicted from the above example is that even if the company is at loss, RDEC makes such companies to immediately claim relief for the qualifying R&D expenditure instead of carrying the increased loss.
A major advantage as depicted from the above example is that even if the company is at loss, RDEC makes such companies to immediately claim relief for the qualifying R&D expenditure instead of carrying the increased loss.
Let’s Wrap Up!
How to calculate R&D for SMEs
To calculate R&D tax credits for SMEs, you need to identify and calculate the qualifying expenditure, which includes staff costs, consumables, software, and subcontractor costs. Enhance the qualifying expenditure by multiplying it by 86% to increase the annual R&D deduction. The rate of relief is up to 21.5% of the qualifying R&D expenditure, which reduces your Corporation Tax bill.
In case a loss making SME wishes to surrender the loss, the company can surrender approximately 18.6% saving from R&D Tax credit (if surrender was not restricted to the losses available) and carry forward any remaining to next year.
How to calculate R&D for RDEC
The Research and Development Expenditure Credit (RDEC) is primarily for large companies, but the incentive is also for those SMEs who, in some instances, can’t use the SME R&D tax credit. To calculate R&D for RDEC, you need to work out the costs that are directly attributable to R&D and reduce any relevant subcontractor or external staff provider costs.
Large companies and SMEs using the RDEC scheme can claim 13% back in tax relief on qualifying R&D expenditure. For expenditure from 1st April 2023, the RDEC rate will increase from 13% to 20%. This means that for every £100 you spend on eligible R&D activity, you receive £20 R&D Expenditure Credit (provided as a cash payment)
Conclusion
In conclusion, claiming your R&D tax credit in the UK can be difficult, but it’s worth it to maximise your refund.
The first step is to figure out how much money you’ve spent on R&D that actually counts, and the second is to figure out which R&D Tax benefit category your business falls under.
To ensure the validity of your claim, it is crucial that you adhere to the rules and regulations established by HMRC. Claiming your R&D tax credit and reaping its benefits requires careful attention to detail and the right approach.
