Blind Them with Science: R&D tax credits
Chancellor Rishi Sunak delivered his first budget last week, which promised a significant increase to public spending, including head-line grabbing announcements like a stimulus package to counter the damage of COVID 19 and a number of tax cuts.
One key announcement that deserves a closer look was the Government’s decision to increase its investment in research and development. This included a boost to the R&D Expenditure Credit scheme from 12% to 13%, allowing larger companies to claim an additional tax benefit from their R&D costs. With that in mind, here’s a timely reminder of Research and Development (R&D) tax credits and why they’re so valuable to companies.
What are R&D tax credits?
When companies incur expenses for Research and Development, these are generally standard deductible costs which are taken away from income to arrive at taxable profit. So far, so simple. R&D tax credits provide a means for companies to make additional tax savings above and beyond the value of the expenditure actually incurred. Depending on the size of the company, and its financial position, the relief can range from a useful deduction from its corporation tax bill to a significant cash refund from HMRC.
The first, and most important, factor in determining the type of relief available is company size. The announcement in this month’s Budget related specifically to the R&D Expenditure Credit (RDEC) scheme, which is the relief mostly applied to large companies – defined as entities with more than 500 staff, whose turnover is above 100 million Euros and/or who have a balance sheet total above 86 million Euros. Companies below this threshold instead claim SME R&D relief. Whilst there were no updates to this second relief in the Budget, it’s already sufficiently generous that no change is really needed.
Next, we’ll look at the two types of relief and how they work.
Large companies – R&D Expenditure Credit
The Budget gave an increase to the RDEC, from 12% to 13%...but 13% of what? Essentially, a large company incurring R&D expenditure will be able to deduct an additional 13% of all qualifying costs from their corporation tax bill. This is on top of already deducting the expenses from income as part of the usual process to calculate a company’s payable tax.
Let’s say a large company spent £100k on R&D. This would be deducted from their income, as usual, and they would work out their corporation tax. They would then be allowed to deduct an extra £12k (£13k once the new rate comes in) directly from their corporation tax liability. If the company is making a loss, they will also be allowed to claim this amount as a cash payment directly from HMRC, rather than carrying it forward to future periods.
RDEC is a good relief, useful to any large company, but what if you’re an SME? Given that the relief is aimed to encourage startups to develop new technological advances, you can expect that SMEs get even more generous reliefs, and you’d be right…
Small and medium companies – SME R&D Relief
Unlike with large companies, where the relief is deducted from the company’s tax bill after it’s been calculated, SME R&D Relief is an additional deduction from taxable profit before HMRC’s cut is worked out. The eventual result – a reduced tax liability – is the same, but the method and the amounts available are different.
How different? The 12% RDEC relief, for a profitable company, is roughly equivalent to an additional 63% of the qualifying expense being deducted from profit. The SME relief, however, allows qualifying companies to deduct an additional 130% of their R&D expenditure before working out their tax. That’s a significant saving.. On top of that, loss-making SMEs – such as many startups – can claim 14.5% of the enhanced expenditure as a cash refund. For a company spending £100k on R&D, this would equate to £33,350 straight back into their bank account.
How can you claim it?
Given the generosity of the reliefs, it shouldn’t be surprising that they come with a number of conditions. Only relevant expenditure is permitted in a claim, which generally means direct R&D costs – such as the wages of staff working on a project – and costs which ‘indirectly support’ the work being done. The criteria for this second category are carefully defined by HMRC, so make sure you find an accountant who understands what’s what, because inaccurate or misleading R&D tax credit claims can lead to an investigation by HMRC. If they believe the claim you’re making is false, you can expect financial punishment as with any attempt at tax evasion.
As well as claiming the right expenses, you also need to demonstrate that your research & development actually is research and development. HMRC define R&D for tax purposes as “when a project seeks to achieve an advance in science or technology”. This generally means that your work has to represent an improvement in the knowledge already existing in the field. Solving a tricky problem for a customer probably won’t count on its own but, if you’re coming up with a new method to solve the problem which could be applied to similar situations in the future, you could well be performing R&D.
Now, HMRC aren’t just going to take your word that you’ve achieved this. As well as the usual information submitted when a company files its tax returns, claiming R&D credits requires that the organisation submits a ‘technical narrative’ to explain what’s being claimed for, and why it represents a valid piece of research and development. Ideally this should be written in collaboration between a person from the project itself, who can explain the technical elements, and a qualified accountant who can put it into HMRC-friendly terms.
R&D tax credits are a great benefit to any business, but also a risky area. If HMRC suspect that the claim is false or misleading, they can and absolutely will launch an investigation, and this blog has barely scratched the surface of the details you need to get right. Qualified accountants, such as Comera Professional, can help you through the process of claiming and make sure everything goes smoothly from the start, freeing up your time to focus on your next breakthrough.