R&D incentives: How businesses can reap the rewards of innovation

Introduced into UK tax legislation in 2000 with the aim of encouraging businesses to increase investment in innovative activities, R&D tax reliefs offer significant benefits for businesses advancing science and technology. Helping organisations to significantly reduce their corporation tax bill, or if loss-making, to generate tax credit repayments, the government established the incentive schemes in order to bring the UK into line with other countries offering similar rewards for innovation, and to boost a vital part of the UK economy.

However, with only around 10% of eligible businesses claiming R&D tax relief and many others failing to apply for the full amount they are entitled to, it is clear that a lack of understanding about what qualifies for R&D relief may be preventing organisations from receiving the credit they deserve.

Which businesses are eligible?

To qualify for R&D tax credits, a business’ R&D activities must meet with detailed criteria set out on HMRC’s website. Generally speaking, a company can claim this form of tax relief if its project “seeks to achieve an advance in overall knowledge or capability in a field of science or technology through the resolution of scientific or technological uncertainty – and not simply an advance in its own state of knowledge or capability.”

While R&D is synonymous in the minds of many with “white coat” scientific research, such as that undertaken in the pharmaceutical industry, the reality is far different. It is also for “brown coat” research seeking to create or improve processes, products or services, or advance technical knowledge, within a range of industries. Examples of qualifying activities include the development of new software for use in-house or new architectural practices.

How can businesses decide which scheme to apply for?

Which scheme a business should apply for will depend on the size of the organisation. Small companies with no more than 500 employees, up to £100m turnover or a balance sheet of less than £86m must apply for R&D tax credits through the Small or Medium-sized Enterprise (SME) scheme, which allows companies to claim 230% of their qualifying R&D costs. This means that for every £100 of qualifying costs, a business could reduce its corporation tax by £130 on top of the £100 spent. Loss-making companies can also, in certain circumstances, surrender their losses in return for a repayable tax credit.

All businesses which do not meet the above thresholds must apply for the less generous RDEC (Research and Development Expenditure Credit) scheme, which offers a credit amount of 11% of the company’s qualifying expenditure. Companies with no corporation tax liability will benefit from RDEC either through a cash payment or a reduction of tax or other duties due. SMEs can also claim under the RDEC scheme if undertaking subcontracted or subsidised research on behalf of a larger organisation.

With companies found to have applied for the wrong scheme at risk of receiving penalties, it is worth taking care to calculate organisation size accurately. Businesses deemed to have made a “careless” error can receive a liability of up to 30% of the benefit received while those found to have made a “deliberate” mistake can receive a fine of up to 70%.

Making a successful claim

The lack of clarity around what qualifies as R&D for the purpose of claiming tax credits means that many businesses may simply assume incentives do not apply to them or, if they do make a claim, may fail to apply for the amount they deserve. This can be the result of organisations only considering core R&D activities whilst failing to account for pre-project or conjoining work which also meets with HMRC’s criteria.

Additionally, while an organisation’s most significant R&D costs are often those associated with starting a project, failure to keep accurate records can often result in this expenditure being neglected when it comes to applying for tax credits. Keeping accurate timesheets from the initial stages of an R&D project can help businesses to track expenditure as they go along, ensuring that all costs incurred are incorporated into a claim to HMRC. As alternative funding of any type can make a difference to the category of tax relief a business can claim for, it is also important to have a comprehensive knowledge of all grants and funding that a company has already received.

As companies found to have made a false claim can receive fines, businesses should make it a priority to develop a clear understanding of what constitutes for eligible R&D activity and plan carefully in order to avoid unnecessary HMRC investigations.

Ultimately, the key to making a successful R&D claim is to convince HMRC that the business both understands its definition of what activities and costs qualify, and that its R&D project meets these requirements fully. With HMRC engaging specific R&D teams to inspect claims, businesses which fail to take a proactive approach to ensuring that applications have the necessary accompanying material may come up against obstacles.

Seeking third party support

In order to increase the likelihood of the claims process going smoothly, applicants may wish to engage the support of an external third party to help prepare a report, known as a “technical narrative”, to accompany claims. Providing relevant information such as company background, what has been done to identify R&D against the official definition and a breakdown of the costs involved, this document aims to address any questions an HMRC inspector may have in advance, helping to successfully navigate any potential enquiry.

Viewing innovation as crucial to the UK economy, the government introduced R&D incentive schemes with the aim of promoting innovation in business, stimulating the country’s economic growth. Despite this, many organisations are still failing to take advantage of the significant benefits the SME and RDEC schemes offer. By developing a clear understanding of HMRC’s complex definition of R&D activity and ensuring this is fully reflected in tax relief claims made, companies can reap the rewards of research and development whilst helping to secure the UK’s status as a global innovator.

Sam Swansborough is an R&D tax manager at Menzies LLP.

Find out more about R&D incentives, and other industry tax reliefs, in Accountancy Age’s guide to the UK corporate system.