The Research & Development (R&D) tax credits help cut the cost of R&D - either by reducing a company's tax bill or, for some loss-making small or medium sized companies (SMEs), by providing a cash sum. The R&D tax credits are available to companies throughout the UK.
The aim of the tax credits is to encourage greater R&D spending in order to promote investment in innovation. It is important to remember that R&D is not confined to companies in the technology sector. Companies in any business involving or using technology may be carrying out qualifying R&D.
A basic definition of qualifying R&D is "activities to resolve scientific or technological uncertainty aimed at achieving an advance in science or technology". Advances include new or improved products, processes and services. If it's obvious to a professional how to do something, doing it isn't R&D. But if there is a 'non-obvious' scientific or technological problem around how to do something, then doing it is probably R&D.
Because of a change in the time given to submit an R&D claim, companies which carried out qualifying R&D between 1 April 2002 and 31 March 2006 had to submit a tax credit claim for that R&D by 31 March 2008. From 1 April 2008, companies are limited to only the prior two years to make a claim – the R&D tax credit has to be claimed in the company's tax return, or by amended return. Companies therefore need to act much faster to ensure that claims are filed in time.
Rates of relief
The amount of relief available has increased for both SMEs and large companies. The rates of relief are:
- 175% of the qualifying R&D costs may be claimed as a tax deduction by SMEs (150% for expenditure prior to 1 August 2008)
- 130% of qualifying costs for large companies (125% for expenditure prior to 1 April 2008).
In addition, SMEs may choose to "trade in" their R&D losses and receive 24.5 pence (24 pence for expenditure prior to 1 August 2008) for each £1 spent on qualifying R&D. 100% allowances are also available on R&D capital expenditure.
There must be qualifying expenditure of at least £10,000 on R&D in the accounting period in order for a claim to be made.
SME qualifying conditions
The qualifying limits for a company to qualify as a SME were doubled with effect from 1 August 2008 so that broadly, a company is a SME if it (together with any company in which it holds 25% or more of the capital or voting rights) has:
- fewer than 500 employees and either
- an annual turnover not exceeding €100 million or
- an annual balance sheet total not exceeding €86 million.
The increase is effective for expenditure incurred on or after 1 August 2008.
The Finance Act 2008 has introduced some additional conditions, effective from 1 August 2008, that also need to be met for expenditure to qualify under the SME regime.
What type of expenditure can a company claim R&D tax credits on?
Companies can claim R&D tax credits for their revenue expenditure on:
- employing staff directly and actively engaged in carrying out R&D
- paying a staff provider for staff provided to the company who are directly and actively engaged in carrying out R&D
- consumable or transformable materials used directly in carrying out R&D (broadly, physical materials which are consumed in the R&D)
- power, water, fuel and computer software used directly in carrying out R&D
Can I claim R&D tax credits as well as a grant for R&D?
Unlike the large company scheme the SME R&D tax credits scheme is a 'notified state aid' and there are limits on the total amount of aid that can be given for projects. Notified state aids are usually government funded grants such as the Grant for Research and Development (although not all government grants are notified state aids). If clarification of the status of a grant is needed, the body that has provided or arranged the funds should be able to help.
A company cannot receive the SME R&D tax credit if it gets another notified state aid for the same project. Where the rules prevent tax credits being claimed under the SME scheme, in certain limited circumstances a claim may be made under the large company scheme instead.
Dealing with a claim for R&D tax credits
Claims for R&D tax credits from companies dealt with outside the Large Business Service are handled by specialist R&D tax credit units. Units are organised on a geographical basis, dealing with claims from companies whose main R&D base is within their postcode allocation. In the Large Business Service, responsibility for dealing with an R&D claim rests with the office responsible for dealing with the tax affairs of the company.
The increase in the thresholds means that more companies will qualify for the more generous rate of relief under the SME regime. The increase in rates also means that the relief becomes even more worthwhile. Spend some time assessing whether you are performing R&D so you do not miss out on the incentives.
If you believe you are entitled to make a claim consider taking professional advice. Don't, however, be afraid to query the advice you receive if you are advised that you do not qualify for relief. There are instances, due to the nature of the rules and the claims process, where professional advisers have simply got it wrong.
If you have been incorrectly advised that you were not entitled to claim relief or your professional advisers have simply missed the deadline for making a claim, consider taking legal advice to recover any losses you may have suffered as a result. You may also need to take legal advice if you were advised to take out a grant when undertaking a R&D project and the lost R&D relief is worth more than the grant. For example, an RDA grant of £200,000 might seem attractive, but it will wipe out all of the SME R&D relief for the whole project (not just for that year, but for the life of a project). For a project with qualifying costs of £1 million, that means forgoing tax deductions of £750,000 or a possible overall tax repayment of £245,000 for loss-making SMEs. The large company relief may be available instead – but if the company receiving the grant sub-contracts substantial parts of its R&D, it won't be able to claim any R&D tax credits on those sub-contract costs. The grant can end up being very expensive.
If you are undertaking a R&D project, to assist your claim for tax credits:
- Create a file of supporting documentation, for example documents that demonstrate that the project is to resolve scientific or technological uncertainty aimed at achieving an advance in science and technology. This may be particularly useful if HM Revenue & Customs (HMRC) query whether the project meets the criteria for a qualifying project.
- Ensure employees complete timesheets to capture revenue expenditure on employing staff directly and actively engaged in carrying out R&D.
- Take some time to ensure you have the right structure in place from the outset. Relief can be restricted or denied if, for example, in the case of SMEs the company does not own the intellectual property arising out of the R&D. Licences and contracts need to support the R&D tax credit position.
Professional advisers should also take note. Concerns have been raised that the R&D tax credit scheme could be failing to reach many of its targets because advisers are unaware that companies qualify or have advised there is no claim only to discover later that businesses were entitled to receive substantial sums from the HMRC.
Advisers that have failed to spot a company's entitlement to R&D relief; failed to make a claim within the appropriate time frame; or have incorrectly advised a company to take a grant for a R&D project and the lost R&D relief is worth more than the grant, could be on the receiving end of a professional negligence claim. It may be sensible to revisit the terms of your retainer with any company you suspect of having a claim to ascertain the scope of your role and whether it may be appropriate to notify your insurers. On a more positive note, advisers should ensure that advice is given now to claim R&D tax credits from 1 April 2006.
Going forward, consider implementing a practice whereby each client, where appropriate, is requested to provide further information and/or documentation relating to any R&D activities it undertakes. This will assist in assessing whether a company is performing R&D which qualifies for relief.