R&D Tax Relief
The key to a successful R&D claim is to ensure you have a thorough technical and practical understanding of the legislation. In our R&D knowledge bureau we share our expertise and answer your questions. If you’ve got a query that’s not addressed here or anything isn’t clear, please feel free to contact us! There isn't a question about R&D tax relief we can't answer!
What counts as an R&D qualifying activity?
HMRC’s definition of R&D is purposefully broad. Whatever size or sector, if a company is taking a risk by attempting to “resolve scientific or technological uncertainties” then it may be carrying out qualifying activity. This could include:
- Creating new products, processes or services.
- Changing or modifying an existing product, process or service.
This means if you’re not sure whether a project is scientifically or technologically possible, or you don’t know how to achieve it in practice, you could be resolving uncertainties and therefore qualify for R&D tax credits.
In a nutshell, if you are trying to improve existing or create new products, services, or processes and you are breaking technical ground in doing so, there is a good chance you are undertaking qualifying R&D.
Can I claim for aborted R&D projects?
Yes! R&D doesn’t have to have been successful to qualify. The fact that a project has been aborted is often a good indicator that R&D has been taken place. If the project has been aborted because the technical hurdles were too high, this suggests there was uncertainty at the start of the project.
How will I know if I qualify for R&D tax relief?
If you’re asking yourself this question, take comfort in the fact that there are many others asking the same question. Often, it isn’t easy to decipher whether or not an activity is qualifying. This is where a conversation with one of our experienced advisers will help. However, if you are confident that you can demonstrate that some kind of technical improvement has been made and that it wasn’t easy or certain on how to achieve the improvement, then there is a good chance you will qualify. One point to note which often comes up in conversation with clients is whether simply improving the state of knowledge within the business qualifies for R&D tax relief. It’s important to note that the company has to be furthering the knowledge in the field of science or technology and not just it’s own knowledge.
Can I claim if I’m a sole trader?
Unfortunately, R&D tax relief is a corporation tax relief which means that business entities which are not subject to corporation tax will not be eligible to claim. Any business which is subject to income tax and not corporation tax will miss out. This means that sole traders and most partnerships will not be allowed to claim.
Tell me about how the SME scheme works
The SME scheme was introduced in 2000 and the potential tax benefits have been steadily increased over the years.
The scheme works by giving additional tax relief on qualifying R&D expenditure and as a result of this, reducing taxable profits or increasing tax losses. The current rate of extra relief on qualifying expenditure is 130% (sometimes expressed as 230% when taking account of the tax relief received on expenditure regardless of making a claim). This means that if a company spends £100,000 on qualifying R&D, an additional deduction of £130,000 is given against taxable profits. Therefore the company receives a total deduction of £230,000 from taxable profits. The current rate of corporation tax in the UK is 19% - this means that a claim which identifies £100,000 of expenditure benefits a company by reducing its tax bill by £24,700. This is is calculated as 130,000 (i.e. the extra relief given by the claim) multiplied by 19%.
When a company is in a loss making position, additional tax relief based on the amount of qualifying expenditure is given in exactly the same manner as a profitable company would receive. The extra relief serves to increase tax losses. For example, if a company has made a loss of £500,000 and identifies £100,000 of qualifying R&D expenditure, the new loss position would be £630,000. This is the extra £130,000 of relief added to the existing £500,000 loss. The company then has a number of options with this loss – carry back, carry forward or surrender to a group company. However, there is a final option called the R&D tax credit.
The R&D tax credit allows the company to ‘surrender’ some or all of the loss to HMRC, in return for a 14.5% payable cash credit. The amount which can be surrendered for the 14.5% credit is capped at the lower of the available loss (in our example, this would be £630,000) or 230% of the actual expenditure identified in the claim (in our example this would be £230,000). Therefore the company would surrender £230,000 of losses in return for a £33,350 payable cash credit (i.e. 14.5%). This is an extremely valuable tax benefit, especially for loss making start up companies that may be developing new technology with little initial income.
Put simply, the SME gives a benefit of somewhere between 24.7% and 33.35% of the qualifying expenditure identified, depending on the company’s tax position.
Tell me about how the RDEC scheme works
The RDEC scheme was introduced on 1st April 2013 as an optional replacement for the older Large Company Scheme (LCS). From 1st April 2016, it became mandatory when the LCS scheme was phased out. The RDEC scheme works in a similar manner to the SME scheme in terms of qualifying costs and qualifying activity, but differs in the way it offers a tax benefit. Instead of giving extra relief like the SME scheme, RDEC gives a taxable credit which reduces the corporation tax liability of the claimant company. It can also give a payable credit to loss making companies (just like the SME scheme – but the actual mechanics of how the credit is produced is different).
From 1st January 2018, the RDEC increased to 12% of qualifying costs. However, companies do not receive the full 12% credit because the credit is taxable. Taxing the 12% credit at the current rate of corporation tax of 19% gives a net benefit to the company of 9.72%. Clearly, this is not as generous as the SME scheme, but it still gives an extremely worthwhile tax benefit.
A key feature of the RDEC scheme is the ability to reflect the credit in the financial statements. This improves accounting performance – something which is particularly attractive the large corporates who may wish to report strong performance to keen eyed shareholders. Reflecting the credit in the financial statements is not mandatory – and our experience has shown that very few companies elect to do this. Where companies do not show the credit in the financial statements, a simple adjustment in the tax computation is required.
Will claiming R&D tax relief affect my accounts?
For SMEs, claiming R&D tax relief will only impact on the tax charge in the accounts. Your accounts won’t look any worse for claiming R&D tax relief – in fact they will only look better due to a reduced tax liability and/or a payable tax credit. Many clients ask us if they make a claim from a previous year, how will it affect that year’s accounts? The simple answer is that it wont! The claim can be reflected in the current year’s accounts and there is no need to amend or restate previous accounts.
For companies claiming under the RDEC scheme, things can be a little different. An RDEC claim can be (but doesn’t have to be) reflected in the accounts. This is a simple adjustment which has a positive impact on accounting performance. However, most companies chose not to reflect an RDEC claim in their accounts and simply make an adjustment in the tax computation.
What do HMRC want to see from an R&D tax claim?
Surprisingly, there is no formal, official template when submitting an R&D tax claim to HMRC. However, our years of experience of dealing with HMRC’s R&D unit has enabled us to develop a robust and reliable reporting format which provides HMRC everything they need to pass judgement on a claim. This includes a comprehensive technical report outlining the projects which meet the qualifying criteria for the relief as well as a detailed financial report which provides a breakdown of the costs included in the claim.
I’ve never claimed R&D tax relief before. Can I claim retrospectively?
Yes! Making a retrospective R&D tax claim follows the normal rules for amending any corporation tax return. In summary, companies can claim up to two years previous. Therefore a company with a December year end could make a claim for the December 2017 accounting period up until the 31 December 2019 (i.e. two years from the end of the accounting period in question).
Can I amend a previous claim?
Yes! Although our advice is to exercise caution where this is the case. Claims which have been submitted but which are still within the amendment window can be resubmitted. This is normally two years from the end of the accounting period in question. However, unless there is a material reason for amending a previous claim, we generally advice against this. When a corporation tax return is amended, the two year enquiry window is reset to zero. This means if you resubmit an R&D claim to make it bigger, you are resetting the enquiry window. If the amendment is only for a small increase in your claim, it might not be worth resetting the clock.
Conversely, if you have submitted a claim which has been materially understated, YesTax would be delighted to assist with any amended claim.
I don’t keep special records of my R&D – does this prevent me from claiming?
No! But there are a few points to note here.
There is no statutory requirement for additional records to be kept by companies who are claiming R&D tax relief. However, the requirement to keep sufficient business records for corporation tax purposes do apply. What this means in practical terms is that HMRC are relatively flexible where records are concerned. For most of our clients, it is relatively easy to extract the relevant cost and technical information using records that are kept during the normal course of business. YesTax can help you put simple and effective measures in place to ensure your R&D record keeping is in good order. We won’t ask you to implement time consuming processes – just a few things to make life easier. By doing this, you will make your claim more robust and given that R&D tax credits are extremely generous, it makes sense to put simple measure in place to make your claim accurate.
I am an SME and have received grant funding – can I still claim R&D tax relief?
The simple answer to this question is Yes!. However, it is likely to affect the scheme in which you claim under (SME or RDEC).
The interaction of grants and R&D tax relief can be complicated, but we’ve summarised the most common situations below.
I’ve received a grant which is notified state aid
Notified state aid grants are bad news for R&D tax claims. Common grants which fall under this category are Innovate UK grants (previously Smart Grants) and any grants which fall under the General Block Exemption Regulations (GBER). If you have received a notified state aid grant which is either specific to the project you want to claim R&D tax relief on or is non-specific (i.e. it covers your general R&D activity), then any claim for R&D tax relief will have to be made under the less generous RDEC scheme. However, if your grant is project specific, it’s important to note that other R&D projects which have been exclusively funded by the company will be eligible for the SME rate.
I’ve received a grant which is not a notified state aid
This situation is slightly better than the one outlined above. Common non-notified state aid grants include Horizon 20/20, FP6 or FP7 and de minimis grants. If you have received one of these grants, then the amount which has been received as funding will need to be claimed under the less generous RDEC scheme. However, any expenditure which the business itself has funded will be eligible for the SME rate of R&D tax relief. Many Horizon 20/20 grants will only fund up to 40% of the total project costs, meaning that the remaining 60% could be eligible for the generous SME rate of R&D relief.
I’ve received a grant – will this affect my claim in any other way?
Quite possibly, Yes! Many SMEs will engage subcontractors as part of their R&D project. As we have seen, when an SME receives grant funding, it often means some or all of the project must be claimed under the RDEC rules. It’s important to note that under the RDEC rules, subcontracted costs are not allowable (unless the subcontractor is an unincorporated entity of a qualifying body). This may mean that a huge chunk of the project cost becomes disallowable for R&D tax relief. It’s therefore very important to speak to us before you accept a grant – forward thinking is the key.
What are the going concern rules?
One of the conditions of claiming R&D tax relief is that the company has to be a going concern at the time the claim is made. A company is a going concern if its latest published accounts were prepared on a going concern basis, and nothing in the accounts suggests that that status depends on its receiving R&D relief or tax credits. Finance Act 2012 also clarified that a company in liquidation or administration cannot make a claim.
What costs can be claimed?
HMRC have six clearly defined categories of qualifying expenditure. These are: staff costs, subcontracted R&D costs, Externally Provided Workers, consumables, software and certain energy costs. We will look at each one in more detail.
What salary costs can I claim?
Salary costs often make up the largest proportion of an R&D claim so it’s imperative that they are correctly handled. The gross salary, employers’ National Insurance, company pension contribution and certain reimbursed expenses can be included as part of an employees salary cost for R&D purposes. It is important to note that the cost of dividends and benefits in kind are excluded. This is a crucial tax planning issue if the directors involved in R&D take a small salary and large dividend.
We are often asked how to apportion an individual’s time to R&D activity when compiling a claim. The simple answer to this is to ensure it apportioned in a just and reasonable manner. We encourage our clients to keep times sheets, but this isn’t always possible. It is important to note that there is no statutory requirement to keep timesheets, but it certainly makes a claim more robust if they are available.
Reimbursed expenditure is not a separate cost category as it forms part of staff costs. However, it is worth explaining in a little more detail as we often get asked about expenses by our clients.
The rules about reimbursed expenditure are a little confusing and often result in confused faces when we explain them to clients! To complicate things further, even HMRC have issued conflicting guidance on the matter! On 27th October 2016, HMRC issued its position on the matter and stated that reimbursed expenditure is qualifying if two requirements are fulfilled. These are:
- The expenditure is initially borne by the employee and not the company
- The expense is directly related to the R&D and is necessary to perform the duties of the person’s job.
What this means is that expenses which are paid for by a company credit card are automatically disallowed from being classed as reimbursed expenses. Many clients are surprised to learn that the method of payment determines whether or not an item can be included in their claim. We recommend you speak to us if you feel you may have a situation where a large amount of R&D expense may be disallowed as a result of the method of payment.
What is a consumable?
For the purposes of R&D tax relief, HMRC’s definition of a consumable is intentionally broad. Any items which are used by the R&D and are no longer so useable in their original form, because they are finished up, or transformed can be classified as R&D consumables. Put simply, this is the stuff which ends up in the bin as a result of the development activity. Common examples include the cost of trial casts by a foundry which have to be scrapped as a result of defects, laboratory materials used by a company which utilises a science lab or the cost of wasted raw materials for a company involved in the manufacture of new and innovative surfactants.
What is a subcontracted cost and how much can I claim?
Subcontracting can be a tricky situation in an R&D tax credit claim, but it doesn’t necessarily mean you can’t claim. You need to clearly understand your contractual situation, the work you are contracted to do and who is bearing the brunt of the cost, as all these can influence the eligibility of subcontracted work.
There are a considerable variety of possible contractual arrangements but the most common is where one company engages another company to carry out R&D activity on its behalf in exchange for payment, with the first company having rights to the intellectual property resulting from the R&D. In this case the first company is sub-contracting the R&D to the second company.
Under the SME scheme, 65% of payments to sub-contractors can be claimed except if the SME is connected to the sub-contractor (e.g. is its parent, part of the same group, or are under common control). The rules are different for connected sub-contractors and it may be possible to claim 100% of the costs. However, this requires certain conditions to be met.
What is an Externally Provided Worker (EPW) and how much can I claim?
The definition of an externally provided worker is a little long and convoluted – to make things easier it’s probably better if we simply call them agency workers. These are workers which are provided by a third party but are under the supervision, direction and control of the company that is making the R&D tax claim. Agency workers are common in a number of sectors which are likely to undertake R&D – these include IT, software, food and drink and manufacturing. HMRC allow companies to claim 65% of the cost they incur from agencies for staff involved in any qualifying R&D project.
Where the company/agency providing the staff is connected for tax purposes to the claimant company, it is possible, providing certain conditions are met, for 100% of the cost incurred to be included in the R&D claim. These are called connected EPWs.
What software costs can I claim?
HMRC allow the cost of software directly employed on R&D projects to be included in an R&D tax claim. Common examples we see include the cost of CAD software for the design department of an engineering firm, the cost of casting simulation software for use on complex metal casts or perhaps the cost of software development licenses for a software company.
The cost of software which is employed on indirect qualifying activities is also allowable. This may include the cost of software employed by the HR department for the R&D staff. However, general software, which is used across the business for activities which are not related to the R&D function, is not a qualifying cost.
It is important to note that the cost of server hire or the cost of data consumed as a result of R&D would not qualify for R&D tax relief under software or consumables.
What energy costs can I claim?
Although HMRC classify energy costs under the consumable category, we prefer to separate this cost into its own category. A reasonable and justifiable proportion of the cost of water, fuel and power (of any kind) is eligible for inclusion in an R&D tax claim. It most cases, this cost is not material to the overall claim, but it’s important to include every cost permissible to ensure a claim is maximised. We have seen advisers in the past assume this cost category is more akin to ‘general overheads’ and often included are items such as rent, rates and general business costs. This is incorrect.
I’ve capitalised some of my R&D costs – can I still include them in the claim?
Yes! But there are some important points to note here. Capital expenditure is not eligible for R&D tax relief – however, just because a company opts to capitalise costs in its accounts does not mean that this is capital expenditure for tax purposes. Many of our clients opt to capitalise staff costs and include the costs in their R&D claim. This is perfectly fine. Staff costs are an excellent example of a cost which can be revenue for tax purposes but capital for accounting purposes. Where this is the case, the cost can be capitalised and included in the R&D tax claim. In simple terms, the accounting treatment of an item is not conclusive as to its classification for tax purposes.
Items such as large plant and equipment, motor vehicles and buildings are both capital for tax purposes and accounting purposes. Where this is the case, they are not allowable as part of an R&D tax claim.
I’m aware there are different schemes for SMEs and large companies. What’s the threshold for an SME?
For R&D tax relief, an SME is defined as a company having fewer than 500 employees and one of the following:
- Less than 100m Euro turnover
- Less than 86m gross assets
This is a relatively simple test to apply when the company is privately owned and not a member of any corporate group. However, where there are linked enterprises or partner enterprises involved, things get a little more complex.
What’s a linked enterprise?
Two companies are linked if one can exercise direct, or indirect, control over the affairs of another, or if both companies are under common control (of another person or persons, including companies or individuals). This has important ramifications for R&D tax relief. If a company is deemed to be linked to another company, the combined turnover, assets and staff count of both companies must be applied to the SME threshold tests. Imagine a situation where a small company with 10 staff and turnover of 600k is 100% owned by a global corporation with 5,000 staff and 600m of turnover. In this scenario, the small company would fail the SME test by virtue of its ownership by the large corporation. Even if the larger company owned 51% of the small company, the SME test would still be failed as 51% indicates the larger company can still exercise control.
What’s a partner enterprise?
Companies that are not linked enterprises can be partner enterprises if one of them holds between 25% and 50% of the capital or voting rights in the other. Where a partner enterprise situation exists, the turnover, gross assets and headcount of the partner enterprise must be brought into the SME test. However, only the relevant percentage of the partner enterprise must be brought into the equation. For example, if a claimant company (A) holds 35% of the capital of voting rights of another company (B), only 35% of B’s turnover, gross assets and headcount must be brought into the test.
Can a company change status from an SME to a large company?
Yes! There are a number of different rules concerning the change of status from an SME to a large company for R&D tax relief purposes (and vice versa). The most important point to note is that companies normally have a year of grace when changing status. This means that if an SME has grown organically and then fails the SME test, it can still claim as an SME in the first year it has failed the test. If the SME test is failed for a second consecutive year, it must then claim as a large company under the RDEC scheme. The same rules apply for a large company which is shrinking and becoming an SME.
An important point to note is that if an SME is acquired by a large company and fails the SME test by virtue of the linked enterprise rules, it has to claim under RDEC immediately. No year of grace rules applies in this situation.
Can my claim trigger an enquiry by HMRC?
Yes! The R&D tax claim is just another part of your overall corporation tax return and normal enquiry window rules apply. YesTax has extensive experience in dealing with enquiries concerning R&D tax claims. In their previous roles, our directors ran an enquiry resolution service for accountants who had made claims which had triggered an enquiry. This gives you peace of mind, knowing that your claim will be handled by advisers with years of experience in dealing with HMRC.
HMRC may open an enquiry into a claim for several reasons. The most common in our experience are:
- HMRC requiring further evidence that the R&D activity being undertaken meets the qualifying criteria for R&D tax relief.
- HMRC requiring further evidence that the company meets the SME definition.
- HMRC expressing concerns that incorrect categories of expenditure have been claimed
- HMRC asking if the company has received any grants or subsidies on the projects being claimed.
- HMRC expressing concerns that the whole of a project has been claimed, rather than just the parts which involved qualifying R&D.
Our 3Es philosophy – Expertise, Ethics and Engagement – really come into play where HMRC enquiries are concerned. Our expertise and ethics mean that your claim will never be artificially inflated. It will be robustly prepared and maximised within the boundaries of tax legislation. This greatly reduces the risk of enquiry, meaning you (and us!) can sleep soundly at night.
Some advisers claim a 100% success rate where claims are concerned. When you’ve been in the game as long as we have, it’s impossible not to attract an enquiry at some point. So we don’t claim a 100% success rate. Anyone can claim this, without it being true. We’re just comfortable knowing our vast experience counts for more than any arbitrary and unproven statistics.
What if my claim contains errors? Will I be penalised?
If an R&D claim contains errors, HMRC may charge penalties which are linked to the amount of tax lost to the exchequer. However, these penalties are dependent on a number of factors. These include whether or not the error was intentional, how forthcoming the tax payer is with information during an enquiry and whether or not reasonable care and attention was made during the preparation of the claim.
By using a specialist advisory firm like YesTax, the risk of error in your claim is substantially reduced.
I’ve made a claim and I’m expecting money back. How long will it take?
For obvious reasons, this is a question we get asked very often! If your claim is for an SME R&D tax credit, HMRC aim to repay monies due within 28 days. However, this is not a statutory requirement and many factors result in this target being missed. HMRC’s R&D units are extremely busy, particularly in December, March and September. Often, claims submitted in these months will be delayed.
Claims for RDEC repayments can take much longer. YesTax has experienced claims taking over 6 months to be processed. This is mainly due to the fact that large companies have more complex tax affairs and often the R&D claim is just a small part of an overall return. If your claim is made under the RDEC, be aware that it may take a while to receive the benefit.
At YesTax, although our staff are well-known to HMRC, it doesn’t mean we receive preferential treatment. HMRC will not give favours to any R&D advisory firm (regardless of what their marketing may claim!). HMRC are impartial and do not move claims made by certain advisers to the top of the pile. We can do our best to get your claim submitted as quickly as possible, but once it’s with HMRC, we can’t move it along any quicker.
I’ve seen that firms offer 100% success guaranteed. Do YesTax offer the same?
No! For the simple reason that no firm can offer 100% success guaranteed! If claim success was 100% guaranteed, there would be no need to use a firm like YesTax!
Many R&D claims are complex and involve (in certain areas) a degree of subjectivity. Our experience means we get it right – but we won’t lie and say this is 100% guaranteed. Claims are reviewed by HMRC and very very occasionally, they may wish to ask further questions or disagree with our interpretation of certain aspects of the claim.
Our reputation, familiarity with HMRC, experience and approach to claims means we get it right. But can this be 100% guaranteed? No. We’d rather be honest than use false claims in our marketing!
I’ve heard about the advanced assurance scheme. What is it and can I use it?
The advanced assurance scheme is a relatively new initiative which was introduced in 2015 which allows companies which have never claimed before to ‘agree’ their first three claims with HMRC. A call or visit from HMRC is arranged which looks at the type of R&D being undertaken by the company. Various aspects of the claim are agreed upfront and providing the nature of the R&D being undertaken does not undergo a material change, HMRC will agree claims for the first three years. Companies that have previously made an R&D tax claim are not eligible for the advanced assurance scheme.
Take up on the advanced assurance scheme has so far been very low. In 2017, only 222 companies applied for the scheme, with a small increase expected in 2018. Our Director, John Moxon, was involved in the consultation during the introduction of the scheme and submitted his comments to HMRC as part of the consultation phase.
I heard about a sting in the tail for R&D tax relief in the October 2018 budget. What’s that all about?
In the 2018 budget, the Chancellor, Philip Hammond, reintroduced a cap on the payable tax credit for loss making companies. A similar cap had been in place until 2012, but was abolished due to concerns that it would adversely affect start-up companies with minimal payroll costs. However, since 2012, there has been a steep rise in the number of ‘artificial corporate structures’ which are designed to take advantage of the uncapped payable credit. From April 2020, a cap will be reintroduced which limits the payable credit to three times the claimant company’s PAYE and NI liabilities for the year. This is unlikely to affect most companies, but any company which solely employs subcontractors will be caught out. If you have any concerns, please contact us.