R&D Tax Credits: What you need to know
The process around applying for research and development (R&D) tax credits might seem complicated. But it is worth doing some simple homework to establish your eligibility. The rewards for your efforts are considerable. Not only do R&D tax credits represent a tax break for UK companies investing in innovation but they also let you reclaim up to 33% of R&D costs, even if your project fails.
In essence, R&D tax credits function as an incentive to companies to invest in research and development. They can also be used as an alternative to innovation grants for R&D funding. In practice, SMEs both profitable and loss-making can get back up to 33p in every £1 they. This happens after the end of the financial year, tax free, and can be used for anything.
The UK government introduced the R&D Tax Credits scheme in 2000 for SMEs, with a separate scheme for large companies launched two years later. Many other countries worldwide – including Canada, France and the US - already operated schemes to promote corporate R&D investment. This added impetus to appeals to the UK government to increase the R&D base by helping to reduce the cost of corporate R&D and thereby encourage companies to invest in it.
There are two main types of R&D incentive structure. The first is volume-based, where the credit is based on the absolute volume of R&D expenditure. The second is incremental-based, where the credit is driven by the increase in R&D spending over a base figure.
The UK scheme is volume-based because of a belief that the incremental approach provides limited or no encouragement to businesses whose R&D spending fluctuates or remains at a steady level (for instance in times of macro-economic volatility).
How R&D Tax Credits Work
Any company carrying out R&D is likely to qualify for the relief. The definitions of eligible R&D and eligible costs are reasonably broad. In addition, eligible R&D activities often take place across the whole range of company operations.
As an aid to understanding what projects might qualify, government funding specialist GrantTree provide some helpful distinctions. The key thing is that you are attempting to solve a technical challenge without a certain outcome. If few others have achieved the same thing, if conducting the R&D was costly (neighbourhood of £100k+), and technological outcome is uncertain, then it likely qualifies. Scale and performance also can be a factor - can you solve challenges at a greater scale or much faster than anyone else through your technology.
What typically doesn't qualify is a simple web or mobile app, or setting up a new business model on an existing website template.
The net benefit after tax of the relief ranges from 7.7-32.63% of eligible expenditure. This depends on whether the claimant is a large or small profitable or loss-making company. The definitions of large and small company size are driven by EU classifications (and adjusted for UK R&D Tax Credit purposes) including revenues, number of employees and balance sheet assets. As a rough guide, an SME should have:
- fewer than 500 staff, and
- less than £85 million turnover or £73 million gross balance sheet assets.
The precise calculations can be daunting depending on your exact situation but as a rule of thumb. if you’re a
- Profitable SME you can expect about 25% of your R&D costs refunded.
- Loss-making you can expect about 33% back.
- Breakeven it can go down to 15%.
If you’re doing R&D in a large company, you can typically get up to 10% of your R&D costs back. So, if you’re running a highly innovative and profitable tech company that’s spending half a million a year on engineers and developers you could get upwards of £125,000 from the R&D Tax Credits scheme.
Don’t worry, HMRC’s R&D requirements are purposefully broad. Whatever size or sector your company is in, if it is taking a risk by attempting to ‘resolve scientific or technological uncertainties’ then you may be carrying out R&D qualifying activity. This could include:
- Creating new products, processes or services.
- Changing or modifying an existing product, process or service.
This means that if you’re not sure your 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.
Within the accepted HMRC research and development definition, R&D doesn’t have to have been successful to qualify. You can also include work undertaken for a client as well as your own projects.
So, what counts as R&D and what costs can you claim for? When putting together an R&D tax credit claim, the following types of qualifying expenditures are relevant:
- Staff including salaries, employer’s NIC and pension contributions
- Subcontractors and freelancers
- Materials and consumables including heat, light and power that are used up or transformed by the R&D process
- Some types of software
Critically, you must map costs to the eligible activities.
Work out When the R&D Activity Starts and Ends
The R&D activity starts when you begin working to resolve the uncertainty. You need to identify the technical issues which require resolution. You also must ensure an existing solution doesn't exist. It ends when you solve the uncertainty or stop working on it. This includes when you have a working prototype and before going 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.
How to Claim
You can make a claim up to two years after the end of the accounting period it relates to.
Once you’ve figured out your eligible R&D activity and mapped the relevant costs, you can claim your tax credits. The claim process is as follows:
- assess qualifying R&D activity
- calculate qualifying R&D expenditure
- submit the figures in the CT600 tax return.
HMRC recommends adequate record-keeping of eligible activities and eligible costs. This is to provide a coherent audit trail in case of an enquiry.