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The government has put R&D tax credits in place to reward innovation and fuel growth in the UK, and with this extra money, it is possible to bring transformation to your business. However, you need to have a clear understanding not only of what R&D tax credits are, but also who can claim them, and how to go about making a claim. Here, we take a closer look at the basics so that you can be well-informed about the government incentive and how it is applicable to your company.
R&D Tax Credits – An Overview
Essentially, R&D or Research and Development tax credits have been launched as an incentive by the government in the UK to reward companies in the United Kingdom for making an investment in innovation. These tax credits represent a valuable cash flow source for companies to use when investing in boosting their research and development, hiring more staff members, and expanding their reach.
How Does The R&D Tax Credit Incentive Work?
Any business that spends money on the development of new services, products, or processes, or on enhancing their existing ones, can claim R&D tax credits. If your company is spending money on innovation, it is possible to make a claim for R&D tax credits and either receive a payment in cash or, alternatively, a reduction in your Corporation Tax.
There is an enormous scope when it comes to identifying research and development, and all sectors can benefit, so it is important to have a clear understanding of what eligibility entails.
Can My Business Claim R&D Tax Credit?
In order to claim R&D tax relief, your business needs to meet the following three criteria:
- It must be a UK-based limited company that pays Corporation Tax
- It must have performed qualifying activities in the field of R&D
- It must have invested money in these projects
In practice, this means that if you have invested in any business project that involves the undertaking of research and development to substantially improve or build a service or product, you should look into claiming R&D tax relief.
It is important to be aware of who cannot claim R&D tax relief, though. For example, partnerships and sole traders are not liable for corporation tax, so they are not eligible for R&D tax credit. Also, companies can only make a claim if they are qualified as an SME (small or midsize enterprise).
That means that the business must have under 500 employees as well as a turnover under 100 million Euros or, alternatively, a balance sheet showing under 86 million Euros.
Although companies that claim R&D tax credit have to have their base within the UK, it is vital to be aware that the R&D activities themselves need not necessarily be performed inside the UK.
Do My Business Activities Count As R&D?
In order to claim this government incentive, another eligibility requirement is that the company has to be performing an activity or project that qualifies as research and development. Two tests exist to establish whether or not an activity or project qualifies.
The first relates to technological advances.
Many small business owners do not realise that their work actually qualifies as a research and development activity, particularly if their company operates in an industry that is not regarded as stereotypically technological.
Nevertheless, for the purpose of claiming this tax credit, the term “technological advance” means simply that the work being carried out is done with the objective of creating something brand-new, or alternatively, to improve considerably on something that currently exists.
A stress on technological advancements is also put on the actual process of performing R&D instead of the outcome, so you could create a process, service, or product that is already in existence in your sector but in an entirely new way which has never been achieved before.
The second relates to technological uncertainties.
Demonstrating technological uncertainty can be done in two different ways, and you can meet either one, or both, to qualify. The technological uncertainty test means only that what the business is attempting to achieve either could not easily be determined by a skilled industry professional or is not known commonly to be already possible within the sector.
That means that if what a business is attempting to achieve has been achieved already but has been kept as a secret within another organisation and therefore is not widely known within the sector, the work still qualifies.
Technological uncertainty can be displayed by explaining the way in which the potential service, process, or product may not fulfil the function that it was intended to fulfil, or that it will work in the intended way but you are uncertain about how it can be achieved. Even if the project is unsuccessful, R&D relief can still be claimed.
All sectors can benefit from R&D tax relief and claimant businesses range from the construction and manufacturing sectors to food production and everything in between.
Which Costs Can Qualify For Tax Credits?
There are many different costs that can qualify for this tax credit. They include:
- Costs relating to staff including their salaries, reimbursed expenses, pension contributions, and employer’s National Insurance contributions.
- The cost of hiring freelancers and subcontractors.
- The cost of consumables and materials including power, light, and heat that are either transformed or used up during the process of R&D.
- The cost of purchasing and using certain kinds of software.
- Payments for subjects in clinical trials.
Are There Different Types Of R&D Tax Credits?
The kind of R&D incentive you need to use when making your claim for R&D relief depends largely on the size of your organisation. If you are running a large organisation, you need to claim under a different incentive to those who are running an SME.
An SME is a business that has under 500 workers and either under 100 million Euros of turnover or under 86 million in gross assets. The majority of businesses, including start-ups, will fall within this category.
A large company has over 500 staff and either over 100 million Euros of turnover or 86 million in gross assets.
If your business is classified for the purposes of R&D tax credits as an SME, the claim must be made under the tax incentive for SME R&D. On the other hand, if your business is a large company, the claim has to be made through a different scheme known as Research and Development Expenditure Credit or RDEC for short.
There are, however, some factors including subcontracting and grants that could prevent a small or medium sized enterprise from being able to access the incentive for SMEs. In those cases, the claim may have to be made via the RDEC scheme, or even through both incentives.
What Is The Value Of An R&D Incentive Claim?
The amount that can be claimed in R&D tax credit will be worked out on the basis of how much you spend on R&D activities. To calculate the amount that you should receive you will have to identify your qualifying expenditure before enhancing it by using the appropriate rate. The figure you come up with will be your business’s enhanced expenditure.
You then either deduct that enhanced expenditure figure from your total taxable profit or, alternatively, add it onto your total amount of loss. If you have made a profit, the answer you come up with will be the amount your corporation tax is reduced by and if you have made a loss, the answer you produce will be the amount you receive in cash credit. In some cases, you may receive a combination of both of these.
What Is The Rate Of R&D Tax Credits?
An SME can claim as much as 33p for each £1 that they spend on activities that qualify as research and development. On average, UK-based SMEs claim £57,228.
Larger companies can claim as much as 11p for each £1 that they spend on activities that qualify as research and development. On average, UK-based large companies can make a claim for RDEC in the sum of approximately £632,931.
Loss-making SMEs can claim up to 33% under the SME tax incentive or 11% under the RDEC scheme.
Profit making SMEs can claim up to 25% under the SME tax incentive or 11% under the RDEC scheme.
Large companies can only claim under the RDEC scheme and can claim at a rate of 11%.
What Benefits Can R&D Tax Credit Bring?
R&D tax credit has been designed to fund innovation in the UK, and as such, it has the capacity to transform a business. Companies that make the most of the tax incentive can grow and expand thanks to the wide-ranging benefits.
Not only does the company itself benefit, but the government does too. Increased productivity is excellent news for our nation’s economy and funding innovation can result in positive changes on a worldwide scale.
How Do I Go About Claiming R&D Tax Credit?
All claims for R&D tax credits are made to HMRC who monitor and process them. Claims can be made going back for two accounting periods.
While it is not legally required, it is recommended that companies get a R&D technical report produced which will justify both the underlying technical uncertainties and technological advancements. It will also detail the expenditure that is eligible and that the business is claiming on the basis of each individual project.
To ensure that the activities that you are claiming for qualify under the existing guidelines as R&D, it is recommended that you contact a tax professional who will check to make sure that you are not making a claim for any projects that are ineligible and that could cause problems with HMRC.
If your business is making a claim for R&D tax relief for the first time, you may wish to consider making an application for AA or Advance Assurance. It is optional to obtain AA but it does allow claims that you make to bypass potential investigations which could be instigated by HMRC during the first three accountancy periods.
This is the reason why it is highly recommended to obtain Advance Assurance as it increases your claim’s efficiency significantly and speeds up your receipt of the payments that you are eligible to receive.
There are several steps to claiming R&D tax relief.
First, you have to work out all of the costs that qualify. In order to make your claim for tax credits, it is necessary to supply a complete breakdown of all of your eligible costs. That is because HMRC needs to see precisely how much your business has spent as well as what it has spent the money on before they can issue your tax refund.
You must not forget to account accurately for any costs that require a proportion applied onto them, for example, utility bills, since this is a very common pitfall that companies can fall into and it will potentially invalidate their claim for R&D tax credit.
Once all of the eligible costs have been worked out, you can work out the total amount of tax relief you will receive, or the “enhancement”. If you are claiming under the R&D scheme for SMEs, you calculate it by multiplying by 130% the total figure for allowable costs before adding it onto your original total for allowable costs.
If your total amount of allowable costs is £150,000 the figure for 130% multiplied by your allowable costs comes to £195,000. When you add those two figures together, you come up with £345,000 which is your total for your enhanced expenditure.
You enter this figure onto the business’s tax return then enter an X into the tax return form’s box 650. In the box 660, enter the figure you have calculated for your enhancement.
When you submit your claim, it will be reviewed by HMRC who will then issue your tax relief.
Will I Receive My Full Enhancement Amount Back?
The amount that you will receive when making a claim for R&D tax credits will be based not only on your total amount of eligible expenditure but on whether or not your business has made a loss or a profit too.
Although some companies believe they will receive the entire amount of their enhancement figure in tax credits, that is not, unfortunately, the case. Rather, different rates will be applied relating to the tax liability of your company.
Here are some example scenarios to demonstrate the amounts you could receive if your eligible expenditure amounted to £150,000:
- If a company makes a profit and pays corporation tax in the amount of £50,000
You receive 19% of your total enhancement figure, which amounts to £195,000 in the form of tax relief on your corporation tax burden. That means the amount of corporation tax you need to pay will be reduced by £37,050, meaning you will pay only £12,950 in corporation tax.
- If a company makes a profit and pays corporation tax in the amount of £25,000
You receive 19% of your total enhancement figure, which amounts to £195,000 in the form of tax relief on your corporation tax burden. That means your whole liability for corporation tax will be cleared and you will have £45,000 of enhanced losses on your business’s tax return.
You then have a choice about whether to receive cash credits in respect of 14.5% of your remaining losses (i.e., £6,525) or, alternatively, carry those losses forward so you can offset them against your future profits. That will create a tax benefit for your business in the future in the value of 19% of your £45,000 in losses which amounts to £8550.
- If a company is making a loss and has total losses worth £150,000
If the company spent £150,000 on qualifying R&D activities, it could opt to receive cash tax credits rather than a reduction on its corporation tax liability. As a result, 14.5% of the enhanced expenditure equates to £50,025.
- If a company is making a loss and has total losses worth £150,000
If the company spent £150,000 on qualifying R&D activities, it could opt to carry that loss forward and offset it against its future profits and future liability for corporation tax. As a result, you can carry 19% of the enhanced expenditure forward, worth £65,550.
I Cannot Claim Under The SME Scheme
If you cannot claim under the SME scheme because your company is not eligible but you are, nevertheless, carrying out qualifying R&D activities, you could claim under the RDEC scheme instead. This scheme has been designed for large companies and is not so generous, but it is accessible to SME companies should they be unable to claim under the SME scheme.
Small companies often make mistakes that stop them from being able to claim R&D tax credit under the SME scheme. The biggest one is failing to plan funding strategically for R&D activities.
It can be difficult to find funding opportunities and many companies do not wish to miss a possible opportunity if one arises, but it is important to assess first how your work can be safeguarded so you can carry on claiming under the SME scheme.