Budget2011: R&D tax credit abolishes caps

GEORGE OSBORNE has hit gold according to experts who believe there are "no negatives" in the announced changes to research and development tax credits.

Small and medium-sized enterprises (SMEs) will receive a boost to tax credits if they spend on research and development. But the fine print goes further than the experts had predicted by changing loopholes to ensure non-profitable businesses reap as many benefits as successful ones.

Around 6,500 SMEs already eligible and using tax credits related to research and development (R&D) costs could see these credits soar. The chancellor is set to increase this type of tax relief to 200% on 1 April 2011, from the current 175%. He will further increase them to 225% on 1 April 2012.

"A huge number of companies claiming the SME R&D relief are hi-tech businesses and start-ups in the technology sector and there is great news today for these businesses," said Diarmuid MacDougall, PwC partner in research and development.

Currently SMEs receive a tax relief of 175% on any money they have spent on research and development. Essentially no tax is paid on any of the R&D costs and companies receive a further 75% discount on corporation tax on profits.

As corporation tax is currently 28% this means the R&D tax credit currently sees companies pay a fraction of that cost, incentivising this industry.

Obviously for profitable companies this is music to their ears. However, what happens to the 75% discount if a company has failed to make a profit?

For those which have spent on R&D and come out losing, the government pays out cash at 14% of the loss the company has made and "surrendered" to them according to current law. The amount repaid is capped to be the same as the total tax paid on employees PAYE and National Insurance contributions.

However, for companies which have a small team but spend a lot on research and development this has meant they hit a glass ceiling on how helpful the tax credit can be.

For example a small technology company with a workforce of five people, which has invested more money in research than it pays out in PAYE and National Insurance, this credit may not be of any value to them.

However, the government has expanded the relief to ensure companies receive their full cash payment irrespective of the amount paid on PAYE and National Insurance which will be available from 2012.

MacDougall explains that this change can be a vital lifeline for SMEs which are continuing to struggle in obtaining credit from banks.

"The full effects of this measure will be truly felt in April 2012 with the introduction of an increased rate of 225% and the withdrawal of the limits on payments for loss making companies," said Kevin Hindley, managing director of Alvarez & Marsal Taxand.

The expense of these changes to the treasury is estimated at £20m for the first year of introduction, rising to £105m in 2014 (see box).

The spike in cost to the treasury is attributed to the fine print, which sees the abolishing of the limit of rebate a company can receive as well as the withdrawal of a limit on how much a company has to spend before they can apply for R&D tax credits.