Research and development (R&D) tax credits can be a valuable tax relief for companies investing in innovation, whether they are developing new products, services and processes or enhancing existing ones. R&D 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 is eligible R&D?
A project must seek to achieve an advance in overall knowledge or capability in the field of science or technology (not simply an advance in the company’s own knowledge or capability). This advance should be 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 is not 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 R&D.
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.
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, rent and data costs.
- Computer software used directly in the R&D.
- 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.
- Expenditure on externally provided workers (ie those workers who are not employees of the company, but are instead paid through an intermediary, such as an agency, to directly and actively be 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, an SME undertaking R&D as a sub-contractor in certain circumstances may instead be able to make a claim under the large company scheme.
Tax relief for SMEs
Tax relief on eligible R&D expenditure for SMEs is 230% from 1 April 2015. In other words, for each £10,000 of eligible expenditure, an SME can claim a corporation tax deduction of £23,000.
For loss-making SMEs, a cash repayment is available providing the SME is a going concern. This repayment is currently equal to 14.5% of the loss arising from the R&D tax deduction (ie up to 33.35% of the actual R&D expenditure).
For accounting periods beginning on or after 1 April 2021, the government intends to restrict the SME R&D payable 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 in total. 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.
Tax relief for large companies
Large companies (ie those which are not SMEs) can also claim tax relief on qualifying R&D expenditure. However, relief is available under a different regime – the R&D Expenditure Credit (RDEC). Unlike the SME scheme, RDEC is usually accounted for ‘above the line’ (ie 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 13% tax credit (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 10.53% of the qualifying expenditure (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. However, there are detailed offset provisions against corporation tax and other taxes, before the credit can be converted into a cash payment.
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 the finance team. 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 is likely to be met. This will enable the company to take more specific advice where required and ensure that a claim is made – and the tax benefits realised – as early as possible.
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.
If you have any questions on the matters discussed in this factsheet, please get in touch with either:
This factsheet is based on legislation and HMRC guidance at 1 February 2021.