The UK Government recognises that encouraging innovation is a vital component in its strategy for improving the UK’s productivity, performance and competitiveness. As a result, the research and development (R&D) incentives for both small and medium size enterprises (SMEs) and large companies have been enhanced in recent years to encourage and reward greater innovation.
When can a Research and Development tax relief claim be made?
Research and development for tax purposes takes place when a project seeks to achieve an advance in science or technology. It will be characterised by an appreciable element of innovation and creativity. Only those activities which directly contribute to this advance through the resolution of scientific or technological uncertainty, not simply an advance in the company’s state of knowledge or capability, are classified as research and development.
Such uncertainty will in practice lead to risk that a project will fail to achieve its aims. A claim can still be made for R&D tax relief even if a project fails.
Be careful, it is not enough that a product is commercially innovative. You can’t make an R&D tax relief claim in respect of projects to develop innovative business products or services that don’t incorporate any advance in physical science or technology.
Claims for R&D tax relief are made as part of the company’s tax return, and must be made within two years of the end of the period of account to which they relate.
Tax relief available for small and medium sized enterprises (SMEs)
The relief available is particularly generous for SMEs. These are defined as independent enterprises with less than 500 employees and with either turnover not exceeding €100m (approximately £87.5m) or gross assets not exceeding €86m (approximately £75.3m).
To be independent no more than 25% of the company’s share capital or voting rights can normally be owned by enterprises which do not qualify as small.
The rules where the company is part of a group, with VC investors or where there are other companies under common control, are complex, so speak to us about your eligibility!
In order to be able to claim enhanced tax relief under the SME R&D scheme the company must be considered to be a going concern.
An SME can obtain tax relief by deducting an additional 130% of its qualifying research and development expenditure when calculating its taxable profits.
The areas of revenue expenditure which qualify for enhanced relief include:
- Staff costs
- Externally provided workers (restricted to 65% of cost)
- Consumable items
- Utilities (power, water, fuel)
- Subcontracted R&D expenditure (restricted to 65% of cost)
- Payments to connected subcontractors
- Computer software
Tax relief for grant funded projects
SME R&D tax relief is not available for the part of any expenditure in respect of which a grant or subsidy is obtained. Where a project has received funding which is notified State Aid, then no expenditure on that project can qualify for the enhanced tax relief or payable tax credit under the SME scheme, but it may be eligible for relief under the R&D schemes available to large companies.
Loss making SMEs
For SMEs that are not making profits, or where the additional R&D relief turns a taxable profit into a loss, the company may claim a payable tax credit. The amount receivable in cash is equivalent to 14.5% of the lower of:
- the whole deduction made in respect of R&D costs
- the taxable trading loss for that accounting period
In cash terms, for every £100 of eligible R&D spend after 1 April 2015, an SME incurring losses may reclaim £33.35 thereon.
Large companies and SME companies in receipt of grant income can make R&D claims under the R&D expenditure credit (RDEC) scheme.
The RDEC scheme was introduced on 1 April 2013 and is marginally more favourable than the previous large company scheme. It takes a different approach to R&D tax relief when compared to the SME scheme – an 11% RDEC (10% to 31 March 2015) is available for qualifying R&D expenditure.
The effective tax saving for expenditure incurred post 31 March 2015 is 8.8%, previously 7.9%.
The RDEC reduces the corporation tax liability of the company as opposed to enhancing the expenditure incurred. Where there is no tax liability, there is potential to claim a payable tax credit from HMRC.
Accounting treatment of Research and Development
Under current UK accounting practice, companies have the choice of whether to capitalise development costs (that are treated as revenue expenditure for tax purposes) as an intangible asset when certain criteria are met, or to immediately recognise such expenditure in the profit and loss account.
Regardless of which of these accounting options is adopted, companies can claim R&D tax relief on their expenditure, even the additional tax credit, in the year it is incurred. Where the revenue expenditure is treated as an asset and R&D tax relief is claimed at that point, no further tax relief is due for the same expenditure when it is amortised or impaired to the profit and loss account.
The rules regarding the taxation of R&D activities are complex, and as a result many taxpayers often fail to take advantage of them. They can be extremely beneficial however, and the tax and cash flow benefits that can be obtained may make a significant contribution in obtaining a successful outcome for a R&D project.
How can we help
Kreston Reeves are leading advisers to SME’s and larger corporates. We have specialists who can assist with your R&D claims. Talk to your usual Kreston Reeves contact or contact us on +44 330 124 1399 to discuss your potential tax savings.
Please contact Scott Miles, Head of Life Science & Technology, for further details or to meet up.
Office 01227 768231
Mobile 078890 64204