R&D Tax Credits

Understanding taxes and finding legal ways to save money on them is often a daunting task. When it comes to property-related taxes, several schemes can help, and one of the most significant yet often overlooked is the Research & Development (R&D) tax credits. Designed to stimulate innovation and growth, R&D tax credits offer companies the chance to reduce their tax bill or receive a cash payment. In this article, we’ll dive into the specifics, helping you understand whether your business activities might qualify for these lucrative credits and how to go about claiming them.

R&D Tax Credits

What are Research and Development Tax Credits and How Do They Work?

R&D tax credits serve as a crucial financial incentive for businesses engaging in innovative activities. Available in the United Kingdom, these credits aim to encourage research and development by providing financial relief.

Throughout the accounting period, businesses undertaking qualifying R&D activities can claim a reduction in Corporation Tax or a cash-back payment, fostering a cycle of continuous innovation and development. The application of R&D tax credits supports companies in mitigating the financial risks associated with ambitious projects, ultimately propelling economic growth and job creation.

It’s important to note that the UK government has outlined several modifications to the R&D reliefs, with some beginning on or after 1 April 2023. In fact, companies that have not submitted either an R&D claim or a claim notification in any of the preceding three accounting periods must now ensure they submit a claim notification within six months after the conclusion of the relevant accounting period. Failure to do so within this timeframe will render the claim invalid.

R&D Tax Credit Incentives for SME Businesses

Small and Medium-sized Enterprises (SMEs) form the backbone of the UK’s economy, and the government recognises the importance of these businesses in driving innovation. R&D tax credits offer a lifeline to SMEs, encouraging them to engage in research and development activities by offering a substantial reduction in their tax liability.

This incentive works on the principle of reimbursing a percentage of the costs that these enterprises incur during their R&D activities. This includes expenses related to staff costs, software, consumables, and subcontractors among others. The most attractive aspect of these credits is that they are applicable even if the project does not succeed, making it a less risky endeavour for SMEs to invest in innovation and development.

The process for research and development tax relief is straightforward, emphasising on the importance of maintaining detailed records of R&D expenses. Many companies make a tax relief claim within more than 6 months after the end of the accounting period (there is currently a 24-month deadline to make claims).

R&D Tax Credit Incentives for Large Companies

For large companies, R&D tax credits provide a different, but equally attractive, form of incentive in the name of Research and Development Expenditure Credit (RDEC). This scheme is designed to stimulate and reward innovation within larger corporations.

Most importantly, RDEC is not limited to companies with a tax liability. This means that even loss-making companies can benefit from the scheme, receiving a payable tax credit. The breadth and scope of eligible R&D activities and costs under RDEC are extensive, covering not only development work research but also indirect supporting activities.

Key eligible costs include staff costs, software or consumable items used in the R&D process, and certain types of subcontracted R&D work. It is crucial to maintain meticulous records of these expenses as they form the basis for your corporation tax relief.

The process to make a claim is incorporated into the company tax return, and similarly to the SME scheme, companies can retrospectively claim for R&D expenditure for up to two accounting periods. 

R&D Tax Credit Incentives for SME Businesses

The Benefits of R&D Tax Credits

R&D tax credits offer a myriad of benefits that extend beyond mere financial incentives, providing a strategic boost to innovative activities. The primary objective is to mitigate the financial risk associated with engaging in research and development, creating a conducive environment for businesses to undertake ambitious projects and push the boundaries of innovation.

From a financial standpoint, R&D tax credits manifest in the form of a substantial cash credit or a reduction in Corporation Tax. This has the potential to significantly enhance your company’s cash flow. The additional funds can then be reinvested into more research and development projects, fostering a continuous cycle of innovation and development throughout the accounting period.

It’s important to note that R&D tax credits operate within the framework of an accounting period, with benefits realized from the beginning to the end of this period. The financial advantages not only reduce the immediate cost burden of research and development activities but also encourage sustained investment in innovation.

Beyond the financial realm, these tax incentives contribute to job creation. As companies gain confidence in allocating resources to R&D, they are more likely to expand their teams to manage these projects effectively. This not only drives innovation but also contributes to economic growth and bolsters the local job market.

Crucially, even if an R&D project does not culminate in a commercially viable product or service, businesses can still reap the rewards of claiming R&D tax credits. This mitigates the inherent risk in any R&D process, empowering companies to explore uncharted territories of innovation without the fear of financial ruin.  

Which Sectors Are Eligible for R&D Tax Claims from HMRC?

To give you an insight into the scope of claims available, here are just a few of the sectors where a claim may exist:

  • Cardboard packaging manufacture
  • Construction
  • Food and drink production
  • Pharmaceuticals/bioscience
  • Recycling
  • Software
  • Electrical Engineering
  • General Contracting
  • Civil Engineering
  • High Tech Distributors
  • Medical Devices

and many more.

What Expenses Qualify for the Research and Development Tax Relief?

To gain the maximum benefit from the Research and Development Tax Relief, it’s essential to understand what constitutes qualifying research and development expenditure. In this section, we will outline the primary types of expenses that can be included in your R&D tax credit claim.

Employee Costs

Employee costs qualify for R&D tax credits. These include remuneration for all staff directly engaged in the R&D process, which typically encompasses salaries, wages, bonuses, and pension contributions. It’s important to note that only the proportion of time that an employee spends on R&D can be claimed. For instance, if a member of staff dedicates half their working hours to a qualifying project, only 50% of their salary would be deemed a qualifying expenditure. Furthermore, Class 1 National Insurance contributions made by the employer can also be included in the claim. However, costs related to benefits in kind or reimbursed expenses are not eligible for R&D tax credit claims. It’s crucial to keep accurate records of all staff time spent on research and development activities to ensure maximum claim potential.  

Contract Research Costs

Contract research costs are also a qualifying R&D expenditure. This involves payments made to external parties for carrying out research and development activities on behalf of your business. Under the SME scheme, companies can reclaim 65% of the relevant payments made to third-party contractors. For the RDEC scheme, the entire cost of payments made to subcontractors can be claimed. It’s crucial to remember that these contracted works must directly contribute to the project of your business to be eligible. In many cases, businesses engage external experts to augment their internal capabilities, accelerate the R&D process, or access specialised knowledge and skills. 

Subcontractor Costs

Subcontractor costs represent another area of significant qualifying expenditure for R&D tax credits. When your business enlists the expertise of a subcontractor to carry out specific R&D tasks, these costs can be included in your tax credit claim. Under the SME scheme, 65% of the costs related to subcontracted R&D work can be included. It’s essential to understand that only the costs directly related to the project can qualify. For instance, if you hire a subcontractor to develop a particular aspect of your innovative product or process, these associated costs are claimable. It’s essential to maintain detailed records of all subcontracted R&D work, including contracts, invoices, and project documentation, to substantiate your claim.

Software Costs

Software costs form another integral part of qualifying expenditure for the R&D relief scheme. If your business has purchased or developed software that has been directly used in research and development activities, these costs can be included in your claim. This can range from specialised software used to run simulations or modelling, to software developed in-house as part of your R&D project. That said, it’s vital to remember that just like with employee costs, only the portion of the software that is directly employed in research and development activities can be claimed. For example, if software is used half of the time for R&D and the rest for other business activities, only 50% of the costs would be eligible. It’s crucial to keep detailed records of software usage in your activities to substantiate your claim. Keep in mind that for accounting periods beginning on or after 1 April 2023, qualifying expenditure is extended to include data licence costs and cloud computing costs. 

Material Costs

Supply costs also count as R&D expenses. If your project requires specific raw materials, components, or consumables that are transformed or used up in the research and development process, these costs can be claimed under the R&D tax credit schemes. These may include the physical materials used in the prototyping, testing, and development phases. However, it’s crucial to note that materials used in the production of goods for sale or in providing your regular business services are not considered eligible. Only those supplies directly used in the R&D process can be claimed. It’s important to keep precise records of these materials and their usage in the activities to substantiate your claim and ensure you receive the maximum possible benefit.

Payments To the Subjects of Clinical Trials

Payments made to subjects participating in clinical trials form another category of qualifying expenditure for R&D tax credit claims. These costs include all payments made to volunteers who take part in the trials, thereby playing a pivotal role in the success of your R&D project. This may include, for instance, compensation for their time, reimbursement of travel expenses, or payments for their participation in a potentially risky treatment. It’s crucial to note, however, that these payments are only eligible for R&D tax credits when the clinical trials are an integral part of the process. Therefore, detailed records of every payment, including the purpose of each clinical trial and the role of each participant, must be maintained to substantiate your claim. This ensures you capture the full value of these costs in your R&D tax credit claim and supports compliance in the claim process.

R&D Tax Credit Rates

The rates for R&D tax credit claims have seen recent changes that affect both profitable and loss-making companies. For profitable businesses utilising the SME R&D tax credits scheme, the tax relief on qualifying expenditure has been reduced from 130% to 86%. Loss-making companies, on the other hand, using the same scheme could previously claim 14.5% of qualifying expenditure as tax credit, but this rate has now been reduced to 10%. This modification in the rates suggests a strategic rebalance in favour of the RDEC scheme.

Meanwhile, for the RDEC scheme, both profitable and loss-making companies have witnessed an increase in tax relief rates. Profitable companies were previously able to claim tax relief of 13% on qualifying expenditures; this has now risen to an encouraging 20%. Similarly, loss-making companies using the RDEC scheme can now claim tax credits at a rate of 20% of qualifying expenditure, marking a significant increase from the previous 13%. These adjustments aim to stimulate further investment in activities across a broad spectrum of industries, fostering innovation, and economic growth.

R&D Tax Credit Rates

Why Elect as Your Research & Development Tax Relief Advisers?

At Elect CA, we understand that the term ‘capital allowances’ can be perplexing for many business owners. Our mission is twofold: to demystify this crucial concept and to assist you in securing one of the most advantageous forms of tax relief available to any business. With a team of experts boasting years of experience in the marketplace, we have developed cutting-edge techniques and processes for accurately gathering data while minimizing disruption to your operations.

Our consultancy expertise is not only grounded in our direct involvement within the capital allowances arena but also stems from our extensive history in the tax industry and quantity surveying. This unique blend of experiences ensures that we provide a comprehensive and knowledgeable service tailored to your specific tax purposes.

When you engage with Elect CA, you gain a partner committed to simplifying the complexities of capital allowances. We take pride in working collaboratively with our accountancy clients, maintaining and enhancing client relationships while offering a valuable additional set of specialist services. Our ultimate aim is to ensure that you obtain the appropriate tax benefit, and we are dedicated to guiding you through the process of submitting a claim. With our expertise, you can navigate the intricacies of capital allowances for maximum tax efficiency.

Why Elect CA as Your Research & Development Tax Return Advisers?

Research and Development Tax Credit Documents

In this section, we will delve into the crucial documents and records that you need to maintain and present when applying for Research and Development (R&D) tax credits.

Help Sheet

The help sheet is an essential document for every R&D claim. It provides invaluable guidance on how to identify qualifying R&D activities and the associated expenditures that can be included in your claim. This document outlines the nuances of the R&D legislation, including definitions of key terms, guidelines on determining eligibility of research and development for tax purposes, and examples of eligible projects and costs. It can be used as a reference tool to help ensure that you are correctly identifying and documenting your research and development activities and expenditures, thereby maximising your claim while remaining compliant with tax laws. 

Qualifying Questionnaire

The qualifying questionnaire plays a crucial role in the R&D tax credit claim process, serving as a pivotal document. Tailored to aid businesses, this tool facilitates the assessment of eligibility for R&D tax credits through a series of targeted questions. These inquiries delve into various aspects, including the nature of your company’s research activities, the innovative components of your projects, and the technical challenges faced. By providing detailed and honest responses, businesses can benchmark their activities against the established criteria for eligibility. The questionnaire functions as a preliminary self-assessment tool, ensuring that time and resources are allocated to viable claims. Accurate and comprehensive answers to these questions are essential, as they form the foundation of your claim’s precision and help in mitigating potential issues, including any future HMRC enquiries.

Research and Development Tax Credit Documents

FAQs

How many companies claim R&D tax credits?

The number of companies claiming R&D tax credits has been steadily increasing, reflecting the growing awareness of these tax benefits among businesses. According to the latest statistics from HM Revenue and Customs (HMRC), over 50,000 companies made R&D tax credit claims in the 2018-2019 financial year, a significant rise from the previous years. It’s important to note, however, that this figure still represents a small fraction of the total number of businesses that could potentially claim R&D tax credits. Many businesses are still not fully aware of their eligibility or how to navigate the claim process, hence the crucial role of professional guidance in this area. Further, these figures continue to grow each year as more businesses realise the value and potential savings associated with R&D tax credit claims.

Is the R&D tax credit refundable?

Yes, R&D tax credits can be refundable, providing an important source of cash flow for many businesses. If your company has paid corporation tax and is eligible for R&D tax credits, these credits can be used to offset your corporation tax bill and any excess can be received as a cash refund. For loss-making businesses, the scheme offers an alternative – the tax credit is fully refundable at a certain percentage of the loss surrendered for the claim. This means that even if your company isn’t making a profit, you can still receive a cash payment. It’s important to remember that the rules and rates may vary, and it’s always beneficial to seek professional advice to ensure that you’re maximising your claim while remaining compliant with tax laws.

What is a good R&D percentage?

The percentage of revenue that a company spends on R&D can vary significantly depending on the industry and the company’s specific business strategy. On average, highly innovative sectors like technology and pharmaceuticals tend to spend a higher proportion of their revenue on R&D, often exceeding 10%. However, there’s no universally ‘good’ R&D percentage. What matters most is that your company’s investment in R&D is aligned with its strategic goals, competitive environment, and market demands. It’s also crucial to ensure that this investment is effectively managed and that it generates a positive return in the form of enhanced product offerings, improved processes, or other forms of innovation.