A Complete Guide to R&D Tax Credits

Research and Development (R&D) tax credits are a valuable source of tax benefits for many UK businesses. The program is designed to help encourage innovation by helping to fund the development of new products, services, and processes that can improve efficiency.

Although research and development tax credits have been around for the past two decades, many companies are still unaware of them and may qualify for this valuable tax advantage. More than 50,000 companies claim R&D tax credits, but many are estimated to benefit from tax credits. It is estimated that only 20% of eligible businesses file a R&D tax credit claim which is attributed to a lack of knowledge of the scheme, a misunderstanding of who qualifies for it, the complexity of claiming this tax advantage and a lack of knowledge on the level of tax relief available to businesses.

A Complete Guide to R&D Tax Credits

What are the tax credits for research and development?

Research and Development Tax Credit schemes is a government initiative that was first set up in the year 2000 but has evolved over the years and has been refined. They are designed to provide a tax break for companies that invest in research and development that could benefit more than the business itself.

Research and Development Tax Credit schemes have been set up to encourage research and development activities in UK businesses by offering them attractive tax relief benefits that reward them for their investment.

R&D tax credits work by reducing a company’s tax liability by adding a credit to a company tax account or making a cash payment. There are a variety of eligibility criteria for R&D tax credits, but the main initial eligibility factor is that the business must be registered to pay corporate tax. The level of tax relief you can receive varies and is directly dependent on the amount of eligible research and development expenditures that the company made during the tax year in which you applied for the exemption.

What are the two types of tax credits for research and development?

The R&D tax credits consist of two distinct schemes that cater to different sizes of businesses. The two schemes are:

  1. Small and Medium Business Scheme designed for small and medium businesses.
  2. Research and Development Expenditure Credits (RDEC) cater to larger companies or those companies that are part of a larger concern.

The SME scheme is designed for small and medium-sized companies with less than 500 employees and a turnover of less than €100m or a balance sheet of less than €86m. Under the SME scheme, a company can claim a higher exemption rate than larger companies under the RDEC scheme, although RDEC claims tend to be for large amounts.

The RDEC scheme is designed for larger companies with more than 500 employees and a turnover above €100m or a balance sheet of more than €86m in line with the SME scheme. Although there are exceptions for SMEs that have been subcontracted by larger companies, they can apply through the RDEC scheme rather than the SME scheme.

What is the value of R&D tax credits?

Based on data from R&D Tax Credit claims for the 2018-19 financial year, the average SME R&D tax credit claim was £57,228 and the average RDEC tax credit claim was £332,160.

The amount you can earn varies by activity and spending level. However, claiming businesses can expect up to 33% tax relief on qualified R&D expenditures through the SME R&D Tax Credit scheme. With the RDEC R&D Tax Credit, companies can expect to receive tax relief in excess of 10% for qualified R&D spending.

Could your business be eligible?

If your business is registered to pay corporate tax and carries out activity that could be considered research and development, you may qualify. The main factor determining whether an activity qualifies for research and development tax credits is that the activity must be seen as technically challenging or innovative in your field. Should be seen as progressive within the industry but not necessarily in the broad business landscape. HRMC expects you to be able to demonstrate this challenge or innovation by demonstrating how progress is identified, investigated and achieved. You will also need to prove that it is of more use than just your business.

When making a claim, it is important to understand what HMRC is looking for in claims and what they really want to see is that there is some level of uncertainty as to whether progress is possible before R&D can be done. They will want you to show how you had to undergo research, testing and analysis in your development of the advancement or innovation. This must be presented to them clearly with supporting evidence.

It is worth noting that R&D projects that are deemed to be unsuccessful but have been completed completely and meet the criteria may also qualify for R&D tax credits since the company has put effort and money behind the R&D activity despite the outcome.

There are no restrictions on the types of industries that can apply for research and development tax credits. To help you understand the types of companies that apply for R&D tax credits, we’ve listed below the sectors making claims in order of the number of claims received in 2018-19:

  • Manufacturing
  • Information and contact
  • Professional, scientific and technical
  • Wholesale and retail trade and repairs
  • Management and support services
  • Building
  • Other service activities
  • Finance and insurance
  • Health and social work
  • Arts, Entertainment and Recreation
  • education
  • Agriculture, forestry and fishing
  • Transportation and storage
  • Water, sanitation and waste
  • Accommodation and food
  • Real estate
  • Electricity, gas, steam and air conditioning
  • Mining and quarrying
  • Public administration, defense and social services

Can loss-making companies claim R&D tax credits?

Companies that incur a loss can still claim research and development tax credits even though they may not have corporate tax liability. Since the rules for receiving tax benefits allow companies to claim the exemption in various ways including a cash rebate, cash credit, loss relief, or future corporate tax savings, this means that it is possible.

Can subcontractors claim R&D tax credits?

Subcontractors can be eligible for R&D tax credits especially if they lead the development of a new product or process. For example, if you are asked to adapt a product that you are offering to a customer to meet their needs but are not told how to do so, you may qualify because you are completing your own research and development to make the adaptation.

How do you claim R&D tax credits?

R&D tax credit claims can be completed on the Entire Company Tax Return Form (CT600) by completing Enhanced Expenses and the online service (gov.uk) can be used to submit supporting documents for your claim. This process applies to both SME and RDEC R&D tax credit schemes. The next section shows how optimized expenditure is calculated.

It is advisable to include a short summary of the claim clearly explaining and highlighting the progress made, what uncertainty was identified and how this uncertainty was investigated and overcome, and why no one in the field could easily do so.

Your claim will need to show the accounting period to which the claim relates and how R&D activity also fits within that period, your company’s unique tax reference number, the total exemption amount claimed, a breakdown of eligible R&D costs and any business losses if applicable.

Losing companies can instead file a claim for a tax credit by converting the tax credit into a cash payment. This needs to be completed in the Intangible Companies Guide to Research and Development.

How do you calculate your R&D expenditures?

You will need to calculate your eligible R&D expenditure by calculating the costs that are directly attributable to the R&D activity undertaken during the claimed accounting period.

The costs of the subcontractor or outsourced personnel provider shall be reduced to 65% of the original cost. The total costs must then be multiplied by 130% to calculate the additional deduction for tax accounts and this needs to be added to the original R&D expense figure to get the amount of the improved expense that you will need to add to your tax return.

What costs can you claim?

There is a wide range of rehabilitation expenses that can include:

  • Staff salaries
  • The employer’s contributions to the National Insurance
  • Employer contributions to the pension
  • Expenses made on subcontractors or workers supplied from abroad
  • Cost of materials or consumables related to research and development activity which can include heat, light and power
  • Purchase some software or software licenses
  • If you run clinical trials, you can include payments for participants
  • If you pay contributions to other organizations for research, you can claim them under the RDEC scheme

Note that this is not an exhaustive list but an example of some of the things that may qualify depending on your R&D activity.

However, some costs cannot be claimed which include:

  • The costs of producing and distributing goods and services
  • No capital expenditure costs
  • Any rent or rates incurred by the company
  • land purchase
  • Any costs related to trademarks or patents

When are the R&D tax credit deadlines?

R&D tax credit claims can be made based on the accounting year of your business and can be claimed after the end of that accounting year. There is also an allowance to allow companies to claim prior accounting years for up to two years after the end of that accounting period.

How are R&D tax credits paid?

It will depend on your business circumstances on how you pay the R&D tax credit. In the first place, the path preferred by HMRC is that if your corporation has a tax liability to pay, the tax credit will be deducted from that liability, so that you have less taxes to pay.

If your business is not liable for corporate tax, you can either get a cash payment or get a reduction on your next tax payment.

If you are in the loss business, a cash deduction or cash credit is also possible. These companies can also mitigate a loss if you were previously profitable so you can take your R&D losses for a tax deduction or you can carry it forward to offset future profits. It is worth exploring which tax benefits option is best for your business before choosing one.

What are common misconceptions about R&D tax credits?

The eligibility of the R&D tax credit scheme is probably one of the biggest misconceptions because many companies do not consider themselves doing research and development. This is large because many only think of traditional research and development and think that it is only for scientific, research or technical work. When in fact it is open to all kinds of businesses regardless of size.

Many companies feel that R&D tax credits are too complex or difficult and not worth the effort. With the average claims being £57,228 for SMEs and £332,160 for larger businesses claiming through the RDEC scheme, it is well worth the effort. And while it may not seem easy for most businesses to do it themselves, there are many accountants or R&D tax credit professionals who can support you in making a claim.

Who can provide support to businesses claiming R&D tax credits?

As indicated, the R&D tax credits are not entirely straightforward and there can be a lot of misconceptions about its eligibility, what activity can be included and understanding the rules for making a claim. This is why there is support available to businesses to help them file claims.

Many firms seek to support their accountant in filing R&D tax credit claims but not all accountants are experienced in filing claims and it may be beneficial to engage the services of a reputable R&D tax credit professional.

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