Small and medium sized companies which incur qualifying R&D expenditure can claim generous corporation relief of 230% x qualifying R&D costs. This means that if a company spends £100 on R&D, it will receive tax relief as if it had spent £230.
Where a company has trading tax losses, it may also be able to surrender the R&D tax relief for a cash tax credit payable by HMRC. This cash credit will be based on 14.5% of what is known as the ‘surrenderable loss’. The surrenderable loss is the lower of:
- 230% x the qualifying R&D spend in the period; and
- the trading tax loss.
From 1 April 2021, the cash payable credit is subject to a cap (see below).
A claim for R&D tax relief must be made within 2 years of the end of the accounting period in which the costs were incurred.
In order to claim R&D tax relief a company must have engaged in R&D activity and then satisfy a number of specific conditions.
To claim relief an R&D report should be submitted along with the company tax return as part of the tax computation.
It’s also helpful if the company’s annual accounts state that R&D work has been undertaken, usually in the Directors’ Report.
What is an SME?
An SME is one with fewer than 500 employees and:
- a turnover up to €100m; or
- total assets in its balance sheet not exceeding €86m.
If an SME is part of a group of companies or is connected to another company or set of companies by way of shareholder control, the above limits are applied to all the connected companies in aggregate.
Definition of R&D
For activity to qualify as R&D there has to be:
- uncertainty that the final aim can be achieved; and
- an advance in science or technology through the resolution of scientific or technological uncertainty.
The knowledge being advanced must not already be available in the public arena.
Qualifying costs
The company must have incurred qualifying revenue expenditure on R&D activity.
Qualifying costs are revenue in nature. They cannot be capital in nature – capital costs are given tax relief separately using capital allowances. However, any qualifying revenue expenditure which has been capitalised in the company’s balance sheet as intangible development costs can be included in a claim.
The rules on qualifying costs are tricky and should be assessed in detail. In summary, qualifying revenue costs are:
- Staff costs apportioned for the time spent on R&D projects.
- Materials consumed or transformed in the R&D process.
- Water, power and fuel.
- Specifically-commissioned parts for prototypes.
- Software bought especially for the R&D project.
- Software designed or adapted as part of the R&D project.
- Subcontractor costs* (unconnected third parties and externally provided workers) – the amount to be included in the claim is restricted to 65% of the qualifying costs.
- Subcontractor costs* (connected parties) – the amount that can be included in the claim is the lower of (a) the payment made to the subcontractor and (b) the relevant expenditure of the subcontractor.
- A proportion of variable overheads.
* The rules for claiming subcontractor costs are complex and contain a number of pitfalls. Careful analysis should be undertaken.
Non-qualifying costs
Some of the types of non-qualifying costs are:
- Market research and advertising.
- Rent and rates.
- Materials not consumed in the R&D process.
- General audit and accountancy fees, payroll costs, tax advice fees.
- Patent and trademark fees.
- Expenditure not charged to the P&L account.
- Capital expenditure.
Using grants and R&D tax relief together
Care should be taken if you plan to apply for grants and R&D tax relief.
Be aware that Government grant funding (known as notified state aid) provided for R&D projects preclude the whole project from any R&D claim under the SME scheme. However, an SME may then claim under the large company the R&D RDEC scheme for the whole of a state-aided project.
Where other grants and subsidies have been received, the SME relief may be claimed on the net amount.
Using grants and R&D tax relief claims together can be done, but you should do your planning. Any SME carrying out qualifying R&D should, therefore, establish the effect of the receipt of a grant before applying, as it may be considerably less advantageous to accept the grant – the R&D RDEC scheme is much less generous that the SME scheme.
The R&D report
A report should be filed as part of the company tax return.
It is current HMRC practice to open an enquiry where no report is supplied.
The report should include the following:
- A summary overview of the company’s business and the R&D projects being carried out.
- Commentary on individual projects, including the advances is science and technology being pursued and the associated uncertainties.
- Details of the staff and subcontractors used on each project and their expertise.
- A summary schedule of the R&D costs, analysing these into key categories (e.g. staff costs, materials consumed, software, subcontractor costs etc).
- A schedule providing a breakdown of how the expenditure included within the summary expenditure schedule has been calculated.
HMRC will generally not accept 100% of an employee’s salary costs within an R&D claim unless it can be clearly shown that they are working full-time on the R&D project.
Where costs are for staff, externally provided workers or subcontractors, these must be paid before an R&D claim is submitted.
HMRC support
HMRC has several specialist units cross the UK which are available to assist with R&D claims.
There is an HMRC R&D advanced assurance scheme for companies claiming for the first time. Where assurance is given, the company will face no further enquiries into its claims for the first three accounting periods.
PAYE cap – effective from 1 April 2021
From 1 April 2021, claims for the cash payable R&D tax credits are subject to a cap as follows:
- Small claims less than the threshold of £20,000 are not be subject to the cap.
- The cap is equal to the £20,000 threshold plus three times the company’s total PAYE and NICs liability for the year.
- There is also an exemption from the cap where a company meets a two-stage test.
- SME companies impacted by the cap will be able to claim the cash payable credit up to the cap, with any unused losses carried forward to be set against future profits.
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