Would you believe your company can save tax up to 21.5% if invested in Research and Development? Yes, HMRC provides huge tax relief for Research and development (R&D). R&D is an activity attempting to:
- Improvise the existing knowledge or process or system or products or machineries, or
- Finding alternative and more efficient methods of producing goods or providing service
Example: When covid 19 spread globally, there was no vaccine against it. The expenditure incurred by Pfizer, a pharmaceutical company, to discover a new vaccine, is R&D (as it is incurred for developing an innovative product to improve public health).
Eligibility for R&D Tax Credits
R&D tax credit is available only for companies (not for sole traders and partnerships) and R&D must be related to science and technology (other areas like arts, literature, religion do not qualify). The company must also be a going concern to claim R&D tax credit. So, companies in liquidation or administration are not eligible.
Eligibility depends not on the industry you are working on but on innovation you are trying to do. A number of businesses can claim R&D tax credits. Few examples are:
- Farming business intending to grow new hybrid crops which are healthier than existing
- Manufacturers intending to design more convenient or cost-effective manufacturing techniques
- Breweries trying to innovate improved brewing practices
Types of R&D Tax Credits
Companies can claim R&D tax credit in two ways:
- Claiming additional expenses (applies to profit making SMEs): this is called SME scheme or
- Claiming tax credit (applies to large companies and loss-making SMEs): this is called R&D tax credit
SME (Small or Medium Sized Enterprise) Scheme
The scheme applies only to SMEs. An SME is a company with “fewer than 500 employees” and “turnover of less than € 100 million or a balance sheet total less than € 86 million”.
Under the scheme, the company can significantly reduce their taxable income by claiming extra 86% of the R&D expenditure. Companies can deduct 186% of total R&D expense (100% as usual, plus 86% as R&D) from the profit. Here, claiming extra 86%, SME scheme can save corporation tax up to 21.5% (i.e., 25% of 86%).
For Example,
Large Ltd incurs £6,000 as R&D to invent bio-fuel for automobiles.
They can reduce taxable profit by claiming R&D of, = 186% of £6,000 (i.e.,£11,160)
Reduction in profit reduces their tax liability by (assuming 25% tax), 25% of £11,160 (i.e., 1,290)
The company saved £1,290 by spending in R&D. Had they spent this amount as normal expenditure (not qualifying as R&D), they could not save tax by £1,290.
R&D Tax Credit for SMEs
As discussed above, SME scheme helps reduce taxable profit. But what if you don’t make profit? There is a separate scheme of R&D claim for SMEs incurring losses. They can surrender whole or part of the loss.
HMRC pays R&D tax credit at the rate of 10% of the surrendered loss.
In the UK, the maximum amount a company can surrender is the total loss suffered. But it cannot surrender more than the amount claimed under SME scheme (i.e., 186% of R&D expense). By claiming tax credit, a company save up to 18.6% (i.e., 10% of 186%) of expenditure.
For Example,
Small Ltd spent £6,000 for R&D. After deducting SMEs scheme, the trading loss is calculated to be £40,000.
Though it suffered loss of £40,000, it can surrender up to £11,160 (the amount claimed under SME scheme, 186% of £6,000).
So, it can claim credit of 10% of £11,160 i.e., £1,116.
R&D Expenditure Credit (RDEC) for Large Companies
The companies other than SMEs are treated as large companies. For large companies in the UK, how R&D relief works is different from R&D relief for SMEs. HMRC allows R&D tax credit of 20% of the qualifying expenditure (was 13% for April 2020 to March 2023).
As the receipt is taxable like trading income, after considering corporation tax of 19% to 25%, what R&D credit saves you is 16.2% to 15% of the expenditure.
Example of R&D Tax Credit Calculation:
If a company spends £500K for R&D:
| RDEC claim (20% of £500K) | £100K |
| Corporation tax payable on receipt (19% to 25% of £100K) | (£19K to £25K) |
| Net receipt | £75K to £81K |
R&D Tax Credit Claim
Both the ‘SME Scheme’ and ‘R&D expenditure credit’ should be claimed through corporation tax return (CT600 form) within 1 year of the company’s year-end. If not claimed then, you should amend the CT return to include R&D claim within 1 year of original filing date.
But for the accounting periods starting from April 2023, the companies applying for R&D tax reliefs/credits for the first time should notify to HMRC of ‘their intention to make R&D claim’ within 6 months of the end of accounting period. Company who have claimed R&D for the past years do not need to notify.
Eligible Expenditure-R&D Tax Credits
Not all the costs incurred by the company qualify for R&D. Below criteria must be met:
- R&D activity must be related to the trade of the company (CTA2009, s.1042)
- It must be incurred on staff salaries, software or consumables, payments to the subjects of clinical trials, subcontractor’s cost, cloud computing cost or externally provided worker.
Cost cannot be claimed for R&D relief if:
- It is capital in nature (including cost of the land) or
- Is subsidised or
- Incurred in the carrying on of activities which are contracted out to the company by any person
- Staff Costs
All kinds of payment or contribution (i.e., salaries, employer’s NICs, employer’s pension contribution) can be claimed (but not the benefits in kind). Cost of the staffs working directly and actively for the R&D project can be fully claimed but cost of the staffs who worked partly for the project should be claimed proportionately.
Cost of staff providing only the administrative support is ineligible (unless the staff are directly and actively involved in the activities which are part of the project activities).
- Software
Cost of software used wholly for R&D project can be claimed for relief (e.g., software to carry out survey, analyse data, identify errors etc). If software is partly used, proportionate amount can be claimed. Software used for general administrative works by the company (workspace platforms like outlook, cost of payroll software, accounting software etc) cannot normally be claimed.
- Consumables
Any consumables like water, utilities, telephone, electricity, stationery etc, used directly for R&D activity or R&D staffs can be wholly claimed. This will be possible when the company has a separate office, or a part of the office used for R&D.
Where a business carries out other normal (non-R&D) activities and R&D activities in the same space, a proportion of the cost (based on floor space used for R&D or number of R&D staff or any reasonable basis) can be claimed.
In the course of R&D, if the company develops or produces some products or materials, and sells these, the income should be adjusted with the cost of consumables/materials.
- Payments to subjects of Clinical Trials
Payments to the participants taking part in the clinical trial is eligible for R&D. Clinical trial is an investigation related to healthcare product.
- Cloud computing
Onwards 1 April 2023, licence costs and cloud computing costs are also eligible for R&D relief. A data licence is a licence to access and use a collection of digital data. Cloud computing includes:
- data storage
- hardware facilities
- operating systems
- software platforms
- Sub-contracted R&D
SMEs, instead of carrying out the R&D by themselves, if they sub-contract, can claim such costs. It can claim the whole cost if the sub-contractor is conncted to it and 65% when not connected (but if unconnected party and the company elect for connected party treatment, whole cost is eligible).
- Externally provided workers (EPW)
When a company carries out R&D through staffs provided by external party, the relevant cost may be eligible for R&D relief. But the below conditions must be met:
- they are an individual (not a company)
- they are not a director or employee of the company
- they have an obligation to provide services personally
- they work under supervision and control of the company
- their services are supplied to the company by or through the staff provider or staff controller (whether or not he is a director or employee of the staff provider or staff controller or any other person)
- they provide, or are under an obligation to provide, those services personally to the company under the terms of a contract between the person and the staff provider
- the provision of those services does not constitute the carrying on of activities contracted out by the company- CIRD84200
R&D Capital Allowances (RDAs)
Capital assets used for R&D activity are not eligible for R&D relief.
But these are eligible for 100% capital allowances. If the asset is later disposed, then the disposal amount is treated as balancing charge (i.e., taxable income).
Significance of RDA
Assets not covered by Annual Investment Allowances: Sometimes, assets like laboratory equipment, servers, computers, machineries etc are required to carry out R&D. If the company cannot claim all of the assets under Annual Investment Allowance, they can claim under RDAs.
Buildings used for R&D: If used for R&D, cost of acquiring the building (except for the cost of land) is eligible for 100% relief. This is extremely beneficial compared to 3% Structural and Building Allowances available normally.
Eligibility for RDAs
Capital expenditure incurred on R&D is eligible for RDAs when it is related to the trade the company is carrying out or is planning to carry out. If only part of capital expenditure is related to trade, claim should be apportioned to the same extent.
Record Keeping for R&D Claim
In case of HMRC enquiry, you need to prove that every penny you claimed qualifies as R&D. Evidence of bookkeeping like ledgers or reports, bank statements, invoices will prove that expenditure actually incurred and were recorded properly.
Similarly, meeting minutes, email, reports etc can prove the relevance of the project activities to R&D. Additionally, timesheet, staff contract, contract with sub-contractors are also important.
Conclusion
Due to the lack of understanding, many companies do not even know they are eligible to claim (and fail to save thousands of taxes). On the other hand, many other claim as they wrongly believe they are eligible and are penalised heavily by HMRC. Hence, getting expert advice is crucial before you claim R&D relief.
Want to maximise R&D claim? Our experts can guide you.
Frequently Asked Questions
What are the changes to R&D tax credit in 2023?
Until March 2023, SMEs could claim 230% of R&D relief but onwards April 2023, they can claim only 186% of R&D expense. Similarly, large companies could claim RDEC of 13% before April 2023 while they can claim 20% onwards April 2023.
Since April 2023, loss making R&D intensive companies can claim RDEC of 14.5% (instead of normal 10%). R&D intensive companies are those who incur more than 40% of total cost as R&D.
How to Account for R&D tax credit?
R&D tax credit is accounted as “tax receivable from HMRC”. The corresponding credit entry in profit and loss account will be “Income”.
Are R&D tax credits taxable?
Yes. For tax purpose, these are treated like other taxable income and taxed at corporation tax rate.
If a large company spends £100,000 in R&D, £20% (i.e., £20,000) is received as tax credit but the company needs to pay corporation tax of 19% to 25% on £20,000.
What is the R&D credit rate?
For large companies, HMRC provides R&D expenditure credit of 20% of R&D expense (was 13% for April 2020 to March 2023).
For SMEs, it is 10% (14.5% before April 2023) of the surrendered amount.
What if my research fails to achieve its objectives?
The purpose of this relief is to encourage investment in innovation. So, even if the research fails to meet its objectives or innovate any product or service or process, R&D is available.
