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November 8, 2023
UK companies spent over £25 billion on Research and Development (R&D) during 2018, and HMRC’s statistics show that the volume of R&D relief claimed by small and medium sized companies (SMEs) is increasing. However, many eligible SMEs are still not claiming the relief. This is often due to a lack of awareness, or a misunderstanding of the requirements for relief. There have also been warnings that that genuine R&D businesses could be impacted by government proposals to combat tax relief abuse. Here, we explore how you can make the most of any R&D tax reliefs available to you.
There are some common misunderstandings around R&D relief for SMEs. The definition of R&D for tax purposes is quite wide – not everything has to be created in a laboratory. This means that some activities may be classed as R&D that might not qualify at first glance.
R&D tax reliefs: the benefits
The government actively encourages companies to carry out R&D in order to promote growth and increase profitability. A wide range of tax incentives exist, which are designed to encourage investment in R&D. Different types of incentives are available, depending on the size of the company. These include an increased deduction for R&D spending, alongside a payable R&D tax credit for those companies not yet in profit.
The government has stated that it is ‘committed to improving access to R&D’ for SMEs.
Claiming R&D tax reliefs
SMEs are permitted to claim R&D tax relief if they have fewer than 500 members of staff and a turnover of under €100 million, or a balance sheet total of less than €86 million. The relief permits SMEs to deduct an additional 130% of qualifying costs from their yearly profit. This is in addition to the normal 100% deduction, giving a total deduction of 230%.
A company may be able to surrender losses for cash repayments in instances where the R&D tax claim creates a tax loss. Currently, this is calculated at 14.5%.
In order to make the most of R&D tax relief, a company must have incurred expenditure on qualifying R&D projects that are related to its trade. Projects must be innovative and should assess and attempt to resolve scientific or technological issues.
Qualifying expenditure falls into different categories. These include staffing costs; software costs; expenditure on consumables or transformable materials; costs of work done by subcontractors; and costs of clinical trial volunteers.
Using the Research and Development Expenditure Credit (RDEC) scheme
The RDEC scheme is a replacement for the large company scheme but can also be used by SMEs that have received a grant or a subsidy for their R&D project or are subcontracted to carry out R&D work by a large company. The credit is taxable and is calculated at 13% of a company’s qualifying R&D expenditure incurred. This credit may be used to discharge the corporation tax liability, depending on whether the company makes a profit or a loss. It could also result in a cash payment. Where no corporation tax is due, the amount can be repaid net of tax or used to settle other debts.
R&D tax credit cap
Government concern about abuse of SME R&D tax relief means that with effect from 1 April 2021, there is a cap on the amount of payable SME tax credit which can be claimed in any period.
If the proposals go through as anticipated, this will be £20,000 plus three times the total PAYE and national insurance contribution (NIC) liability for the period. The PAYE/NICs bill to look at is not just the bill for those involved in the R&D work: it applies to the company’s entire PAYE and NICs spend, as well as the PAYE and NICs of connected persons carrying out subcontract R&D for the company or supplying workers to the company.
There have been warnings that genuine businesses will be impacted, but the measure is not intended to penalise bona fide claimants.
Companies claiming a payable credit less than £20,000 will not be affected. If the company meets two tests, a claim of any size will not be capped. The conditions are that its employees are creating, preparing to create, or managing intellectual property; and that less than 15% of its R&D qualifying expenditure is spent with connected persons.
How we can help
R&D tax relief is sometimes said to be a missed opportunity for SMEs, who often undertake an innovative scientific or technological project advancing their business, without realising the activity could qualify for relief.
If you want to know more about R&D tax relief, please don’t hesitate to contact Rachel Warriner (Head of Corporate Tax) for an in-depth discussion.