As the government encourages more innovation among UK businesses, yours could be in line for some R&D tax relief, says Adam Bernstein.
Don’t let the tax tail wag the investment dog, goes the saying. In other words, it doesn’t always make sense to follow a particular course of action because the tax system seems to make it worthwhile.
That said, your business may be involved with research and development (R&D) – and you may be eligible to claim R&D (tax) relief on the costs.
Yen-Pei Chen, manager of corporate reporting and tax at the ACCA, an accounting professional body, has seen the number of R&D relief claims from companies both large and small increase massively in recent years.
“Data published by HMRC in September (2018) shows a doubling from 2013-14, to 43,040 claims in 2015-16 , with claims for 2016-17 already totalling nearly £3.5bn. The majority (more than 34,000) of the claims have been made by SMEs.”
She adds: “If you haven’t already, it’s worth looking at the kind of R&D activities your business is undertaking, to make sure that you’re not missing out on potentially large tax deductions, or even a cheque from the taxman.”
The R&D reliefs regime is a core part of the government’s drive to encourage innovative businesses in the UK. Claiming may not be a walk in the park; but compared with other aspects of our centuries-old tax legislation, R&D tax credits are relatively friendly, once you get to know them.
Statistically, R&D relief is by no means reserved for large companies and there are two types:
SME R&D relief is available to SMEs with less than 500 staff, and either a turnover of under €100m or a balance sheet total of under €86m. The SME tax credit gives a total 230% deduction on qualifying R&D expenses. This means that every £100 of R&D expenses would give you £43.70 off your tax bill (£100 x 230% at the 2018/19 main rate of corporation tax of 19%).
Research and development expenditure credit (RDEC) is available to large companies, as well as SMEs who have been subcontracted to carry out R&D work for large companies. Having replaced the large company R&D scheme in 2016, Chen explains that RDEC is calculated at 11% of the qualifying R&D expenses.
But it’s not all plain sailing, she adds: “The bad news first: this 11% tax credit is taxable (so it has to be added back to your net profits in calculating your taxable profit for the year). The good news? Loss-making companies get the tax credit in cash.”
But there is a word of caution: If a company is backed by external investors or is part of a group, its eligibility for SME relief could be subject to rules for linked or partner companies. Further, if State Aid is received for an R&D project it would not be eligible for SME relief – although it could still qualify for RDEC.
What activities qualify as R&D?
Although the two reliefs are calculated differently, they share many of the same basic rules about qualifying activities and qualifying expenses.
“The statute books are unequivocal on expenses,” says Chen, “to qualify for R&D relief, you must be doing work that ‘advances overall knowledge or capability in a field of science or technology.’ And here, ‘science or technology’ means science or technology.”
She clarifies with the example of a firm developing new containers that give the microwaveable meals in them a longer shelf-life as qualifying for R&D; developing new containers that make the meals look much more appealing to shoppers does not. “No matter how innovative the artistic design, it’s not R&D in the eyes of the tax man: the innovation is in marketing, not in science or technology.”
And then there’s the word “overall”. Chen says that this means that you must be aiming to create an advance in an overall field, not just for your business. “For example, a taxi cab company that’s upgrading its GPS mapping system to make their booking processes more efficient would not get R&D tax credits. Similarly, a drinks manufacturer that develops a secret recipe for a new line of fizzy drinks would not get the tax credits, because that only advances the business’ own product offerings.”
Another key criterion is that you must be trying to overcome “an uncertainty that competent professionals can’t readily resolve.” On this Chen says: “There has to be uncertainty at the outset as to how to achieve the outcome you’re seeking, or whether it is scientifically possible or technologically feasible. Anything that could be resolved by hiring a consultant for a few months, or sitting down in a meeting with the company’s engineers, would most likely not qualify as R&D.”
Typically, tax law is complex and so she offers yet another example: “A car maker designs a new petrol engine and exhaust that performs as well as a standard engine, but emits much less pollution. This would pass the test. However, adapting an engine design already used in a car to improve the performance of a different brand of cars would not.”
It’s worth noting that even if a project ultimately fails, it could still qualify as R&D.
What expenses qualify?
The rules are quite clear on this says Chen. She notes that staff costs, often a big part of R&D expenses, are covered by both reliefs provided “the staff in question are directly and actively engaged in the R&D project.” But slightly different rules apply to different kinds of staff.
For employees, their salaries and wages, national insurance contributions and pension contributions all qualify for R&D tax credits. A portion of the costs for supervisory or managerial staff could also qualify. The costs for administrative support staff would most likely not qualify, barring a few exceptions.
In terms of subcontractors, normally 65% of subcontractor costs would qualify, but different rules apply if the staff provider is connected to the company. Also, subcontractor costs do not qualify for RDEC.
And as for externally provided workers, some costs would qualify for people directly working on the R&D project, but recruitment costs would not.
In addition, you can claim the day-to-day costs relating to materials and utilities, including electricity and water bills. Software costs can also be counted: where a piece of software is only used partly for the R&D project, the relevant cost will need to be apportioned.
“Remember,” says Chen, “R&D expenses qualify for relief only when they relate to resolving scientific or technological uncertainties. Any costs linked to market research, initial feasibility studies, patent applications, production and distribution are excluded.”
R&D reliefs are for the day-to-day running costs of R&D projects. So capital expenditure, such as plant, machinery and buildings, won’t qualify.
However, as Chen points out, things can get a bit confusing when tax and accounting rules interact. “For example, the International Financial Reporting Standards require companies to capitalise staff and material costs from the development phase of R&D projects, if they meet certain criteria. So, does this mean that capitalising staff costs in the accounts prevent you from getting R&D tax credits on them?”
The answer, she says, is no, noting HMRC’s internal manual: “The accounts treatment (involving either recognition of an asset on the balance sheet or the write off of expenditure immediately to the profit and loss account) is not conclusive of whether the expenditure is revenue or capital for tax purposes.”
In other words, for R&D relief, Chen advises following the tax rules, not the accounting rules – “if your staff costs qualify for R&D tax credits, it doesn’t matter whether they’re recorded as expenses in your P&L or as part of an asset on your balance sheet.”
How to claim
Luckily, the procedure for claim R&D tax relief is straightforward because it can be claimed through the full company tax return (CT600). It helps if you can provide a brief summary of your project to support the claim.
HMRC advises that the summary should answer the following four questions:
• What is the scientific or technological advance that the company is trying to create?
• What scientific or technological uncertainties were encountered?
• How and when were the scientific or technological uncertainties overcome?
• Why wasn’t the knowledge being sought readily deducible by competent professionals?
“Helpfully,” adds Chen, “HMRC now offers companies applying for SME R&D relief for the first time the option of obtaining Advance Assurance . This gives them early guarantee that their R&D will be accepted”.
Just because you may have qualified for R&D relief but have not yet made a claim, don’t think that it’s too late – it’s not. You have 12 months after the original tax filing deadline to make a backdated claim. If you need help to understand more about the process, speak to your accountant. Don’t lose out through lack of knowledge.
About the author:
Adam Bernstein is a business writer with 25 years’ experience.
ETN | Better Business - April 2019