The Government is revisiting Research and Development (R&D) tax relief to keep up with technology and support UK innovation. Find out which reliefs you could claim.
R&D tax relief will help reduce Corporation Tax and could even mean a cash payment from HMRC. The Government’s renewed focus on the relief aims to support modern research methods and additional legislation will be introduced in the Finance Bill 2022/23 The government intends to expand qualifying expenditure to include data and cloud costs. Costs in relation to pure mathematics (potentially useful in AI research) will qualify for R&D purposes.
The changes will also incentivise UK innovation by restricting claims for overseas activities carried out by subcontractors and externally provided staff.
Crucially, in order to make a valid claim, a Claim Notification must first be submitted to HMRC within 6 months of the end of the accounting period to which the R&D claim relates. It is intended to apply only to new claims post 1 April 2023 or where there has been no claim in the last 3 accounting periods. The innovative nature of the insurance sector has already allowed many companies to benefit from R&D, and we expect this trend to continue.
The R&D relief available
There are two types of relief, depending on the size of the company – or the group it is part of.
SMEs benefit from R&D tax relief which allows them to:
- deduct an extra 130% of qualifying costs from their yearly profit (added to the normal 100% deduction), making a total 230% deduction
or
- if the company is loss making, claim a tax credit worth up to 14.5% of the surrenderable loss.
Large groups are eligible for R&D expenditure credit (RDEC). This is also available to SMEs subcontracted to do R&D work by a large company, or which have received a grant or subsidy for their R&D project.
The credit is calculated at 13% of the qualifying R&D expenditure (incurred on or after 1 April 2020) and is taxable. Depending on the company’s taxable profit or loss, the credit may be used to discharge the tax liability or result in a cash payment.
The criteria for SMEs
An SME company or group is defined as one with:
- less than 500 staff
and
- a turnover of under €100m or a balance sheet total under €86m (EU definitions still remain).
This must include the staff, turnover and balance sheet total of all connected companies. A group includes all companies where more than 50% of the voting rights are owned by the parent company. And where the group has any partner relationships (25% to 49.9% ownership), only a percentage of the staff, turnover and balance sheet are included in the total.
What counts as R&D?
HMRC’s definition of R&D is where a company looks to innovate, research or develop an advance in its field. It can even be claimed on unsuccessful projects. The project must relate to the company’s trade – either an existing one, or one that is intended to start up based on the results of the R&D. The project may research or develop a new process, product or service or improve on an existing one. HMRC guidelines require a company to:
Show it is an advance in the field
The project must aim to create an advance in the overall field, not just the business. The use of existing technology, albeit for the first time, is not an advancement. But the process, product or service can be ‘an advance’ if it’s been developed by another company but is not publicly known or available.
Show that a professional in the field could not work this out
HMRC specifies that the solution cannot be easily worked out by a professional or that other attempts to conduct the process or develop the product have failed. Professionals working on the project may explain the uncertainties involved.
Show there was uncertainty
HMRC also considers that “a scientific or technological uncertainty exists when an expert on the subject cannot say if something is technologically possible or how it can be done – even after referring to all available evidence.” This means that the company or experts cannot already know about the advance or the way it has been achieved through the R&D.
Explain how the company tried to overcome the uncertainty
It’s important to explain the work done to overcome the uncertainty or difficult technological problem. This can be a simple description of the successes and failures during the project. Or the creation of new processes, products or services by making notable improvements to existing ones using science and technology. But pure product development does not qualify.
Which costs can you claim?
Costs are eligible from the day the project begins and until the advance is developed, discovered or the project is stopped.
Employee costs
For staff working directly on the R&D project, you can claim a proportion of their salaries, wages, Class 1 National Insurance contributions and pension fund contributions. You can claim for administrative staff who directly support the project. But not for general clerical or maintenance work that would have been done anyway, like managing payroll.
You can also claim 65% of the relevant payments made to an external agency if they provide staff for the project.
Subcontractor costs
Under the SME scheme a company may claim 65% of the relevant costs of using a subcontractor. But under the RDEC scheme subcontracted expenditure cannot be claimed unless it’s directly undertaken by a charity, higher education institute, scientific research organisation, health service body or an individual or partnership of individuals.
Consumable items
A claim can also be made for the relevant proportion of consumable items (materials and utilities) used for the R&D.
Costs that cannot be claimed
These include the production and distribution of goods and services, capital expenditure, the cost of land, patents and trademarks, rent or rates.
Start date of the R&D activity
The R&D activity starts when you begin working to resolve the uncertainty. You must identify the technical issues to be resolved. The project ends when the uncertainty or advance is solved or achieved or there is a decision to stop working on it. The activity for which you claim R&D relief is considered over once you have a working prototype that solves the problem, and before you go into production.
Your R&D may restart if you find another scientific or technological uncertainty after you’ve started producing the product. If this happens, you can claim for further R&D while you try to resolve it.
You can make a claim for R&D relief up to two years after the end of the accounting period it relates to.
SME scheme relief
Under the SME scheme relief is given by making an adjustment in the computation of taxable profit. Where all the conditions are satisfied, an extra 130% of the qualifying expenditure is deducted to provide .
Losses that arise can be used in the same way as any other trading losses – including surrender as group relief.
In some circumstances the losses can be surrendered in return for a payable credit. You must make the claim in your Corporation Tax return or as an amendment to your return within a year of the filing date.
It’s important to note that the R&D tax credit is not taxable income of the company.
For accounting periods starting on or after 1 April 2021, the amount of payable tax credit that a company is entitled to for an accounting period is the lesser of:
- 14.5% of the surrenderable loss for that period
or
- the sum of £20,000 plus 300% of the company’s relevant expenditure on workers for payment periods that end in the accounting period.
Alternative relief (RDEC) for a non-SME group
Companies that fall outside the SME limits must calculate their RDEC as follows:
- Determine the costs directly attributable (employee, consumables etc) to the R&D project
- Add 65% of subcontractor or external staff provider payments
- Multiply this figure by 13% to get the expenditure credit
- Enter the figure into the Corporation Tax return (as it is subject to tax).
How credit is applied
RDEC must be applied in the following order:
- The expenditure credit must be used to settle the current period’s Corporation Tax liability.
- Where the company is loss making, a notional tax charge is applied to the expenditure credit.
- The credit is limited to the company’s total expenditure on R&D workers’ PAYE and National Insurance contributions for the accounting period. Any amount over this limit will be added to expenditure credit in the next accounting period.
- The credit may then be used to pay any outstanding Corporation Tax liabilities for any accounting period.
- The credit can then be surrendered in whole or part to any group member.
- Thereafter, the credit may be used to discharge any other company tax liabilities, like VAT or liabilities under a contract settlement.
- Finally, any amount remaining can be paid to the company.
Accounting for the RDEC
The expenditure credit a company receives under the RDEC scheme is treated as taxable income. The Government’s plan was to allow the incentive to be part of the Statement of Income and Retained Earnings and so form part of pre-tax profit. There is nothing stipulating where the credit should be recorded, other than above the line. It can be shown as Other Income or even set against the R&D expenditure.
If you have any questions about issues raised in this article, please contact Chris Riley.
