R&D Tax Credits are a valuable tax relief for companies investing in innovation, whether they are developing new products, services and processes or enhancing existing ones.
R&D tax credits comes in the form of tax credits are not restricted to particular industries: they are potentially available wherever a company is seeking to resolve a scientific or technological uncertainty, regardless of the field.
Companies should, therefore, ensure they consider whether R&D credits might be available whenever they undertake significant development projects, to ensure that they benefit from relief where it is available.
What type R&D is eligible for relief?
A project must seek to achieve an advance in overall knowledge or capability in the field of science or technology (including pure mathematics from 1 April 2023) and not simply an advance in the company’s own knowledge or capability. This advance should be sought through the resolution of scientific or technological uncertainty.
Scientific or technological uncertainty exists when the knowledge of whether something is possible or feasible, or how to achieve it in practice, is not readily available or deducible. The uncertainty can also arise from turning something that is established as scientifically feasible into a cost-effective product or service.
Even if a particular advance in science or technology has already been made or attempted by someone else, if the details are not readily available (for example it may be a trade secret), work to achieve that advance can still be eligible R&D.
A project which seeks to make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes can be eligible R&D. If the scientific or technological advance sought by the project isn’t achieved or not fully realised, this can still be eligible R&D.
In contrast, improvements, optimisations and fine tuning which do not materially affect the underlying technology will not be eligible R&D. Similarly, routine analysis, copying or adapting an existing product, process or material will not be eligible
Revenue v Capital Spend
The rules described in this factsheet apply to revenue expenditure – either expensed or classified as an intangible fixed asset. Expenditure on capital assets used in the R&D work is eligible for a capital allowance at 100%, so that the expenditure is fully relieved in the year it is incurred.
Whilst R&D relief for revenue expenses is available only to companies, there is no restriction on the type of business that can claim these capital allowances.
Eligible Expenditure for R&D Tax Credits
The main costs which are eligible for R&D relief are:
- The costs of employing staff who are actively engaged in carrying out the R&D itself.
- Materials that are used directly in carrying out the R&D and are consumed or transformed in that process. Expenditure incurred on items which are later sold or transferred as part of the company’s ordinary business cannot be included.
- Power, water and fuel costs used directly in carrying out the R&D, but not other costs such as telecommunications and rent costs.
- Computer software used directly in the R&D.
- Costs of datasets and of cloud computing services (from 1 April 2023).
- Sub-contracted R&D expenditure, usually when an SME sub-contracts certain activities within the R&D project. Under the SME scheme, eligible expenditure is usually restricted to 65% of the payment to the sub-contractor, unless the subcontractor is connected. Large companies can claim subcontractor costs in full but only in limited situations. Until 1 April 2024, qualifying subcontractor costs include costs of UK and overseas subcontractors.
- Expenditure on externally provided workers (eg those workers who are not employees of the company, but are instead paid through an intermediary, such as an agency, to be directly and actively engaged in a company’s R&D). Usually, these costs are restricted to 65% of the staff provision payment.
An SME, for R&D purposes, is a company with fewer than 500 employees and either turnover not exceeding €100 million or gross assets not exceeding €86 million. The consolidated worldwide group is considered in determining the size of the enterprise, as well as considering any linked or partner enterprises (eg joint ventures) which are the subject of more detailed rules.
Care in preparing a claim is needed when an SME has received a grant, subsidy or customer contribution, as relief may be reduced or even denied. In particular, if all or some of the costs of a project are met by a grant or subsidy that is notified state aid, the expenditure on the project will not qualify for the SME relief.
However, SMEs that are unable to claim the SME relief in these circumstances may still be able to claim relief available to large companies.
Relief is not available under the SME rules if the company is itself undertaking R&D as a sub-contractor. However, in this case a claim may be possible under the large company scheme.
R&D Tax Credits for SMEs
Tax relief on eligible R&D expenditure for SMEs is 186% from 1 April 2023 (230% between 1 April 2015 and 31 March 2023). In other words, for each £10,000 of eligible expenditure, a SME can claim a corporation tax deduction of £18,600 (£23,000 between 1 April 2015 and 31 March 2023).
For loss-making SMEs, R&D tax credit in the form of a cash repayment is available providing the SME is a going concern. This repayment is equal to 10% of the loss arising from the R&D tax deduction for expenditure incurred from 1 April 2023, recouping up to 18.6% of the actual R&D expenditure incurred (14.5% for expenditure incurred between 1 April 2015 and 31 March 2023, recouping up to 33.35% of the actual R&D expenditure).
If the SME is a R&D intensive company, where R&D expenditure is 40% or greater of its total expenditure for an accounting period (including connected companies), a loss-making company can surrender losses at a rate of 14.5% for expenditure incurred on or after 1 April 2023. For accounting periods beginning on or after 1 April 2021, restrictions exist to limit the SME R&D repayable tax credit to three times the PAYE and National Insurance paid by the company and PAYE and National Insurance costs incurred by connected companies on R&D related externally provided workers and/ or subcontracted R&D in the accounting period.
There is a cap on the amount that an SME can claim in R&D relief on any one particular project of €7.5 million. Where an extensive project could exceed this cap, it is worth considering whether the project could qualify as multiple separate projects. It’s worth noting that any qualifying expenditure exceeding the €7.5 million cap could still qualify for relief under the large company scheme.
R&D Tax Credits for Large Companies
Large companies (eg those which are not SMEs) can also claim tax relief on qualifying R&D expenditure under a different regime – the R&D Expenditure Credit (RDEC). Unlike the SME scheme, RDEC is usually accounted for ‘above the line’ (eg as part of EBITDA) for accounting purposes. This may impact cost-based contracts, staff bonuses, the reported tax rate and other financial ratios. The impact of accounting for the RDEC should therefore be explored before a claim is made.
Under RDEC, a company can claim a 20% tax credit (13% for R&D expenditure incurred between 1 April 2020 and 31 March 2023, and 12% for R&D expenditure incurred between 1 January 2018 and 31 March 2020 and 11% before 1 January 2018) on R&D spend. The RDEC is itself taxable and so there is an effective tax saving of up to 15% of the qualifying expenditure (10.53% between 1 April 2020 and 31 March 2023, and 9.7% and 8.8% before April 2020 and January 2018 respectively). A feature of RDEC is that the credit can be claimed as a cash repayment although there are detailed offset provisions against corporation tax and other taxes before this is possible.
A key issue for companies outside what might be termed ‘traditional’ R&D sectors, such as pharmaceuticals and technology, is how to ensure qualifying R&D projects undertaken and associated costs are identified by both the finance team and the company’s competent professionals. This may mean that there needs to be better communication between the finance and project teams, particularly early in a project, to ensure that there is an understanding of whether the key criteria around seeking an advance in scientific or technical knowledge are likely to be met.
This will enable the company to take more timely and specific advice where required and ensure that a claim is made – and the tax benefits realised – as early as possible.
For accounting periods beginning on or after 1 April 2023, first time claimants and companies which have not made a claim for three years will have to notify HMRC within six months of the end of the period that they are intending to make a claim.
Companies also need to be aware of an imminent change relating to claim information requirements. Companies making claims on or after 1 August 2023 must provide a digital additional information form with their claims. It therefore makes sense for claims that are currently in progress to aim to complete and submit them ahead of 1 August 2023 to avoid this extra requirement.
How we can help
Having undertaken claims for companies of all sizes from all sectors (including but not limited to manufacturing, IT, pharmaceutical, construction, food and beverage and agricultural), we ensure that claims are both maximised and robust. We can undertake a review to help you to identify whether any of your activities might constitute R&D, which projects qualify as eligible R&D, and the specific costs which are eligible expenditure.
Alternatively, if you have already submitted R&D tax credit claims but HM Revenue & Customs (HMRC) has raised queries, we can work with you and manage the enquiry process to help achieve a desirable conclusion.
This factsheet is based on legislation and HMRC guidance at 1 May 2023.
- Claiming Research and Development (R&D) Tax Reliefs – HM Revenue & Customs
- Tax Relief for Research and Development in the Construction Sector – Saffery
- Generous Tax Relief for Progressive Farming Businesses – Saffery