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R&D Tax Credits have been designed to allow businesses incurring costs during the development of processes, software, services, or products to receive a deduction from their corporation tax or, alternatively, an HMRC cash payment.
As R&D tax credits can encourage innovation while increasing spending on research and development related activities for UK-based companies, it is essential to understand how they work and how you can maximise their potential for your business. In this in-depth look at R&D tax credits, we examine eligibility, benefits, and the claiming process.
R&D Tax Credits – What Are They?
R&D (research and development) tax credits have been created to help encourage greater innovation whilst also boosting spending on research and development activities for UK-operational companies.
The incentive has been introduced by the government to encourage greater investment in R&D, and it allows the recovery of as much as 33.35% of a business’s R&D expenditure in the form of a cash payment or a Corporation Tax reduction.
During 2020, 85,900 claims for R&D tax credits were made – an increase of 16% on the figures from 2019. As a result, the total value of tax relief for R&D activities paid out during 2020 amounted to over £7 billion.
R&D Tax Credit Eligibility
Companies across all industries could be eligible to receive R&D tax credit. In order to meet current requirements, the business must have participated in qualifying activities within the sphere of R&D including:
- The creation of new services, processes, or products
- The changing or modification of an existing service or product
To claim R&D tax credit, your business musts meet the below eligibility criteria:
- It must be a company in the UK that pays Corporation Tax
- It must be an ongoing concern
- It must not be either in liquidation or administration
- It must be undertaking R&D qualifying activities
- It must have paid money for those R&D qualifying activities
There are some other criteria too that has to be considered in order to make a claim for R&D tax relief. Subcontracting and grants are also relevant factors, and therefore, it is always best to seek out professional advice before preparing a claim.
If you are operating as a sole trader, you cannot claim R&D tax credit. That is because only companies liable for Corporation Tax in the UK can claim these tax credits. As sole traders pay no Corporation Tax in the UK, they are unable to make a claim for R&D tax credit.
Companies operating as an LLP (Limited Liability Partnership) are also ineligible to apply for R&D tax relief. That is because, like sole traders, LLPs pay no Corporation Tax in the UK.
When it comes to companies that are limited by guarantee, however, making a claim for R&D tax credits is possible so long as the company meets all of the standard eligibility criteria.
Companies limited by guarantee are companies without share capital, with members and not shareholders. Their members’ liability is limited to the total amount that the members are contributing to the companies’ assets. Often, companies of this nature are not-for-profit companies, with profits that are reinvested in the business instead of being distributed amongst their members. As long as the company is liable to Corporation Tax in the UK, it can claim for R&D tax relief.
What Benefits Do R&D Tax Credits Bring?
R&D tax credits represent a valuable source of financial business support, helping companies across every sector within the UK as they develop world-leading services, processes, and products. R&D tax credits bring:
- A vital source of funding that is non-repayable to enterprises of all sizes
- Encouragement for businesses to make greater investment in innovation, research, and development
- A boost to economic growth – every £1 that is spent on R&D in the public domain delivers around £7 in net economic benefits for the country and opens up another £1.40 of R&D private investment.
- Make the UK squarely at the front of innovation, research, and development worldwide.
What Counts As Research & Development For The Purposes Of Tax Relief?
For the purpose of tax relief, R&D takes place whenever a project aims to achieve advancements in technology or science through resolving technological or scientific uncertainties. In order to do this, the company must be working to increase the overall capabilities or knowledge within a specific field, but they need not necessarily fully achieve their goal. Even if the project fails, R&D has nevertheless taken place.
You may still be able to claim R&D tax credit for products that have been developed already but in order to do this, the information about how those original products were developed cannot be readily deducible or publicly available.
When those details have been withheld, it is still possible to make an R&D tax credit claim for the solution that you have devised. You may also be eligible to apply for research and development tax credits if your business has created a product with identical performance characteristics to an already existing solution but in a way that is fundamentally different.
Similar products may both be qualified for research and development tax credits in such cases so long as your business was seeking an advancement in technology or science and facing technological or scientific uncertainty.
As for what does not count for R&D purposes – an adaptation, routine analysis, or outright copy of an existing product will not count as it will have sought no advancement in technology or science. Nevertheless, it can be challenging to determine which activities count for R&D purposes, so seeking professional advice is always sensible before making a tax credits claim.
How Do I Know If My Company Meets The Eligibility Criteria To Claim R&D Tax Credit?
If your business takes risks by improving, developing, or innovating a service, product, or process, it will likely be eligible to claim R&D tax credit. One way of determining whether your scope of work qualifies as research and development is whether the project team was facing an uncertain outcome when the project was launched. If it was unknown at the outset of your project whether a specific outcome could be achieved, and if you are able to demonstrate that the project goes further than just applying technologies that already exist, your business may have eligibility to claim.
Are There Different Tax Credit Schemes For R&D Activities?
Depending on how large your company is, and whether or not your business is a subcontractor for the project, there are different R&D tax credit schemes you can apply for.
- The first is the R&D tax credit scheme for small and medium-sized enterprises (SMEs)
- The second is the RDEC scheme for large companies.
To be classified as a small and medium-sized enterprise for R&D tax credits purposes, your business must have under 500 employees and either gross assets amounting to under €86 million or a turnover amounting to under €100 million. Companies with under 500 staff members that breach the balance sheet and turnover thresholds, are classified as large companies for the purpose of R&D tax credits.
Companies should be aware, however, that their status for R&D tax credits purposes may change if the staff turnover, head count, or gross assets change. That will determine whether your business falls into either the RDEC (R&D expenditure credit) or SME research and development tax credits scheme.
Since the scheme for SMEs is significantly more generous when compared with the scheme for larger organisations, most businesses will be keen to make an application for their R&D tax credit under the SMEs scheme wherever possible.
Nevertheless, as businesses are constantly evolving, it is inevitable that some SMEs eventually will outgrow those limits. In some cases, larger companies even find that they fall beneath them, for example, after reducing their workforce size. Those changes do not affect the status of the company until all of the conditions have been met for the grace period of 2 consecutive years.
There is, however, one exception to the rule. If the SME is taken over by a larger group or company, there is a suspension to the grace period provision. The SME will become a large organisation during the acquisition period and this will be applicable for that whole period, and not only from the acquisition date.
If a company’s status changes from a large organisation to an SME or vice-versa, its overall research and development tax credits benefit will be changed too. There are different rates for R&C tax credits between the RDEC and SME tax credits schemes. If your business changes from an SME to become a large business, its R&D tax credits will reduce to 10p instead of 33p for each £1 that it spends on research and development activities. Some other differences exist between the schemes too, including the kinds of expenditure that you can include in the claim, and the mechanism via which relief is received.
It is also important to note that there are some occasions when a business that otherwise would qualify under the SMEs scheme has to make its claim for some or all of its research and development expenditure under the larger business RDEC scheme. This occurs if the business is carrying out research and development on a subcontracted basis or if it has received specific kinds of funding from grants. Seeking professional advice is always recommended in such cases to ensure that maximum tax relief benefit is being claimed.
How Do Subcontracting And Grants Affect R&D Tax Relief?
If your company is carrying out R&D works as a subcontractor for a larger company, this affects your tax relief claim. A key condition for companies wishing to claim for R&D tax relief under the SMEs scheme is the expenditure must not be incurred by undertaking R&D in the role of a subcontractor. When an SME is an R&D subcontractor for a large organisation, the SME is permitted to make a claim for tax credit, but it can only do so under the RDEC scheme. If the company is successful, it can receive a gross deduction of 13% for all of its qualifying research and development expenses.
If your business has been in receipt of a funding grant for its R&D project, it can still claim R&D tax credits. However, you can only make an application under the RDEC scheme. In practice, that means if your business has only received a small grant, the company may overall lose money since some grants reduce significantly the amount a company may receive in tax credits.
The difference the company may claim for under the RDEC scheme and a potential claim value under the SMEs scheme may be considerably greater than the total amount of the grant. That is why seeking professional advice is always so important when you are making a claim for R&D tax credits.
What Will Happen If My Business Outsources Some Of Its Research And Development Activities To A Third Party?
So long as qualifying R&D activities are undertaken by the third party or subcontractor, your business may still make an R&D tax credits claim. It is possible to claim as much as 65^ of your qualifying costs when a third party has no connection to your organisation. The work that your business has subcontracted out does not necessarily be classified in its own right as R&D but it should be part of an R&D larger project.
At the present time there are no requirements for subcontractors for R&D projects to be resident in the UK or undertake the work within the UK. It is important to note, though, that for all accounting periods beginning on 1 April 2023 that will change. Relief for all subcontracted activities will then be limited to those taking place only inside the UK. That will also be applicable to all Externally Provided (agency) Workers. Some narrow exceptions will exist to this, so speaking with an experienced adviser is essential.
For any RDEC scheme claims, subcontractors have to be qualifying bodies or individuals to have eligibility. They cannot be a limited company.
Can I Make A Retrospective R&D Tax Credit Claim?
Businesses are permitted to submit a claim for R&D tax credits any time until the 1st anniversary of their company tax return’s due filing date for the period during which their claim is being made. In practice, that means the company is permitted to make their R&D tax credit claim going back for two accounting years. Businesses can make their claim in the company’s tax return or, alternatively, in a tax return amendment.
If a claim is made late, it is unlikely that it will be allowed by HMRC on the grounds of having insufficient time or a lack of awareness of the scheme. Nevertheless, an appeal’s success will always depend on each case and its facts.
The good news is that you do not have to restate your previous accounts or file them again with amendments in order to claim R&D tax credit. This type of claim for tax credits may be dealt with as a prior-year adjustment when submitting the accounts for the following period. However, it is important to note that the way that R&D tax credit is treated for SMEs is different to the way in which it is handled for large company claims.
Although you may restate the previous accounts if you wish, it would be unusual to take this course of action. You only need to restate your accounts if they are Companies Act non-compliant. The amount of Corporation Tax that is shown in the accounts is merely a provision and, therefore, any changes subsequently to your company’s liability will generally not require a restatement of the accounts.
Which Costs And Activities Are Applicable For R&D Tax Relief Purposes?
It’s possible to claim tax relief on any costs expenses via your Profit and Loss account. In some circumstances, it is also possible to make a claim for capitalised expenditure as long as the purchased assets are classified as being Intangible Assets. R&D tax credits may be claimed on any daily expenditure for operational costs, however capital expenditure on any fixed assets like land or buildings, is not usually eligible within an R&D claim.
The primary cost areas that are claimable include:
- Staff costs
- Agency workers
- Freelancers and subcontractors
- Software licensing costs
- Any payments made to clinical trial subjects
Large businesses may also include contributions made to research organisations or individuals where qualifying research and development works were carried out.
Let us take a closer look at those qualifying costs in more detail.
For both large companies and SMEs this category may include:
- Gross salaries. These will include wages, cash bonuses, and overtime pay.
- Employer’s NI contributions
- Employer’s pension contributions
- Specific business expenses that have been reimbursed
All “benefits in kind” like company cars or private medical insurance are excluded specifically from the category or staffing costs. Director dividends can also not be included. That can have a significant effect on your claim’s value if your company directors spend a lot of their working time on R&D activities.
While some directors or employees may be entirely engaged with research and development activities, more commonly staff will only be engaged partly in R&D. Therefore, you must determine the total amount of their staffing costs in an appropriate apportionment when including them in an R&D claim.
Costs that are permitted to be included for subcontractors differ between the RDEC and SME schemes. Money that companies spend on subcontractors will not normally be eligible for R&D tax relief under RDEC claims, but some exceptions do exist. For businesses making SME claims, 65% of all payments they make to unconnected third parties can be included. For subcontractors that are “connected” there are more complicated rules which have their basis on the subcontractor expenditure’s nature.
EPWs or externally provided workers are individuals that are provided to a business via an agency or staff provider. EPWs are required to operate via the staff provider rather than directly contracting as individuals with your business.
Agency staff, freelancers, and contractors are all common examples of EPWs. When performing R&D activities, EPWs are required to work underneath the direction, control, or supervision of your company.
When EPWs carry out both non-R&D and R&D activities, appropriate apportionments must be applicable to your expenditure. For all “unconnected” EPWs, the payments that you can include in an R&D tax credits claim are limited to 65%. Special rules are applicable for any connected EPWs.
Any materials transformed or consumed during your R&D processes are classified as consumables. These include fuel, power, and water. All expenditure on such materials can be included within a claim, including materials that are used when constructing prototypes or during trials.
When the work on resolving the scientific or technological uncertainty has come to an end, all extra expenses for consumables (e.g., materials for marketing or cosmetic fine-tuning) are not permitted to be included within the claim. Only the cost of consumables relating to the R&D work must be included, which may be different from the costs for consumables for the entire developed product, material, service, or process.
The revenue you expend on software for computers involved in research and development activities can be included. If software is only used partly for R&D activities, it may be included if reasonably apportioned.
Volunteers for clinical trials:
Typically, this category will only feature in R&D activities within the pharmaceutical sector. If a company pays individuals who have an involvement in a clinic trial to test a drug’s efficiency under the scope of a research and development project the expenditure may be included as part of the company’s R&D claim.
It is not usual to be able to include costs for VAT in your R&D claim. There is an exception to the rule, however. If VAT costs cannot be recovered via VAT returns, you may include them in your research and development tax credits claim.
Whether or not your business can include VAT costs depends on its VAT classification. There are 4 different classifications for VAT:
- Zero Rate
- Reduced Rate
- Standard Rate
Businesses with a zero, reduced, or standard rating can recover input VAT (i.e. VAT on costs) in a VAT return and therefore, R&D expenditure related CAT costs cannot be included in a claim for R&D tax credits.
Companies that have an exempt classification, however, cannot recover their input VAT in VAT returns. Therefore, the VAT forms a component of the services and goods that it is charged to and so it can be included within a claim for R&D tax credits.
Expenditure on utilities, materials, and sub-contractors can all attract VAT so these must be correctly handled according to the VAT classification of your business. Usually, staffing costs represent the largest element of your claim for R&D tax credits and those attract no VAT so, in a lot of cases, VAT has limited relevance to R&D tax credits claims.
When it comes down to subsistence and travel costs, these may also form part of your R&D claim. Companies can reimburse expenses that are initially incurred by employees and these may then be reclaimable within their R&D tax credits claims so long as the following criteria are met:
- It constitutes a cost to the business of employing employees, and
- It is a cost that the staff member pays to fulfil their employment’s requirements.
It does not necessarily mean, though, that expenses automatically qualify within the category or staffing costs simply because a staff member has incurred the expense initially. If the expenditure is directly settled by the business with a vendor, for example via the company’s credit card, it will not be classified as a reimbursable expense whether or not it relates to R&D activities. The reason for this is that the expense was not borne by an employee initially.
It is, nevertheless, possible for reimbursed expenses to be included in claims for R&D tax credits as long as they are:
- In respect of subsistence or travel expenses that were incurred by an employee then reclaimed afterwards, rather than being directly paid for by the company; and
- Classified as staffing costs; and
- Directly relate to research and development activities.
The expense, however, must have been incurred in the process of performing the job so it cannot include training expenses or travelling to work costs that have been reimbursed.
Can R&D Tax Credit Be Claimed If I Pay No NIC And PAYE?
It is still possible to claim R&D tax credit if you pay no NIC or PAYE so long as your business otherwise qualifies.
In the past, it was impossible to claim cash credits when no NIC or PAYE had been paid, but in 2012, that restriction was removed. As a result, you may have eligibility to make a claim on the basis of your other qualifying expenses, even when no salary is drawn.
Claiming in such circumstances depends on if you use the RDEC or SME tax credits scheme.
If you are claiming under the SME scheme without any NIC or PAYE, the money you spend on freelancers and subcontractors as well as any contributions to pensions you may qualify as expenditure for R&D together with employer’s national insurance and salaries. Some other costs may also be applicable including the costs of materials used during the research and development process, some costs relating to software, and consumables such as power, light, and heat. R&D tax credit can be claimed on all revenue expenditure, but capital expenditure cannot usually be included within your claim.
If you are running a large company, it is likely that you will only pay no NIC and PAYE if your company forms part of a larger group with salaries being paid from an organisation outside the UK. Under the RDEC scheme, you can still make a claim but it could affect when the claim benefit is received.
If the claim benefit is received through offsetting your liability for Corporation Tax, paying no NIC or PAYE will not affect your claim. But, once the liability for Corporation Tax is offset, you may also have cash credit due which NIC and PAYE could affect. Cash credits under RDEC are limited to the total NIC and PAYE amount paid for staff members performing research and development activities and who are included within the claim.
Nevertheless, the claim benefit will not be lost. Any amount above the cap may be carried on to be used in the future. Therefore, if you carry out qualifying research and development activities you should still claim, even if you pay no NIC or PAYE.
Must I Claim A Minimum Expenditure Amount When Applying For R&D Tax Credits?
There is no minimum amount you have to spend on qualifying R&D in order to submit your claim for R&D tax credits. However, in the past, there were minimum expenditure amounts that had to be met. Before 1st April 2012, a minimum amount of £10,000 in qualifying R&D project expenditure had to be made to file a claim. Since 1st April 2012, that is the case no longer. Whatever the amount of qualifying research and development expenditure your business has, it can make a claim for R&D tax credits.
What Requirements Are There For R & D Tax Credit Record Keeping?
When making an R&D tax credits claim, record keeping forms a key component. HMRC has set no specific requirements for record keeping but they have an expectation of some type of record being available to them.
It is accepted by HMRC that those claiming for the first time, or those who are in the first three years of claiming, are likely to have no detailed records available to support the entirety of their research and development spend. Planning materials, workflow tracking, and meeting notes are all excellent examples of records that may be kept in order to support a claim.
Record keeping for R&D tax credit purposes must begin by determining which projects are eligible for this tax relief. Work qualifying for research and development tax relief has to not only have a relevance to your business’s trade, but it must also form part of a particular project that seeks advancement in technology or science.
Once you have identified which projects you are working on qualify for R&D, you must consider your project’s boundaries before determining which project expenditure may be used within your claim. In many cases, the biggest R&D cost is the staff costs of individuals working on the project. Not only must you identify who on your staff team has had an involvement in the project, but also which activities they carried out and the proportion overall of their time that they spent on those activities.
When working out the amount of time spent on R&D projects, the following advice should prove helpful:
R&D begins when work on resolving the technological and scientific uncertainties begin. R&D ends when those uncertainties have been resolved or the work on resolving them has ceased. This is known as the Research and Development Project Period.
A project period might begin or come to an end during a period of accounting. Therefore all staff time spent on each of your R&D projects must be accordingly apportioned. Working out the accurate apportioning of your staff’s time spent undertaking qualifying R&D project activities depends on your work’s nature as well as the records you have put in place. Staff who join or leave your company during that year also must be considered as well as any staff who work part time.
The job roles of different members of staff must be separated between those who contribute directly to R&D activities and those whose roles only support activities indirectly. Keeping and maintaining a contemporaneous time-keeping system is always a good idea, but a formal system of keeping timesheets may not always be necessary. When no time records are in place, you will need to allocate staff time on a reasonable and just basis.
It is important to be aware that individuals working in different areas of your company may have an involvement in R&D activities. Although engineers and developers have a greater chance of being involved with research and development than marketing executives, it is crucial to always assess the involvement of an individual and the role that they actually had in the qualifying project instead of simply considering their job’s title.
The official title of an individual’s job is not as important as the determination of if they undertook indirect or direct qualifying R&D activities. Your business’s size, your total number of workers, and the quality and nature of records you keep affect how easy it is to identify who is and is not involved in R&D projects, and the extent to which each worker was involved.
Senior engineers and CTOs are typical candidates to be included in R&D tax credit claims as they are almost always involved directly in R&D activities. Sales managers and marketing directors are not as likely to be included since their activities tend to focus on customer engagement and commercial aspects of your business.
Nevertheless, there are some cases where members of staff who, on the face of things, do not appear to work in R&D, actually have specific qualifications or skills that mean they had an involvement in research and development beyond their typical daily activities. In such cases, you can include some of their allotted work time within your claim.
Do not overlook indirect qualifying activities top. For example, an administrator may spend some of their working day writing up the notes from project meetings, and this is an indirect qualifying activity.
Which CT600 Section Must I Complete When I Make A Claim For R&D Tax Credits?
You must complete the full CT600 tax return, not the short tax return when claiming R&D tax credits.
For SMEs, the CT600 (2015) V.3 must be used, with these boxes completed:
· Box 650 – a tick must be entered into this space.
· Box 660 – the total amount of enhanced R & D tax relief must be inserted here i.e., your original expenditure on R&D plus the extra enhanced research and development tax relief.
· Box 875
· Box L168 and L168A on the form CT600L
You should be aware that if you have never made a claim for R&D tax credits before, you must inform HMRC about your intention to claim in advance using the digital service. This must be done within six months of the period end to which your claim relates.
How Are R & D Tax Credits Treated For Accountancy Purposes?
Research and development tax credits can be accounted for in a few ways, depending on if you make your claim under the RDEC or SME schemes.
Under the SME scheme, the tax credit is not part of your business’s taxable income. It will, therefore, be illustrated in your income statement as a Corporation Tax adjustment. You can do this either before you finalise your statutory accounts relating to the year for which your claim is being made or, alternatively, retrospectively, which is done by an under/over provision to your corporation tax amount.
For RDEC claims, the tax credits form part of your business’s income for the purposes of corporation tax in the UK. This can be accounted for in several ways, and seeking professional accountancy advice is, therefore, crucial before you attempt to file your tax credits claim.
Is There An Online R&D Tax Credits Service?
HMRC has launched an online R&D tax credits service that summarises the result of your qualifying costs calculations before providing the information in a format that is standardised to HMRC. Online services are available for both SMEs and large businesses using the RDEC scheme.
To determine which documentation must be included or to find out more about how the information can be submitted, you should seek professional advice from a team of highly skilled and experienced accountants who have an in-depth knowledge and understanding of all aspects of R&D tax credits and how to claim them.