Making the most of R&D relief

Although HMRC statistics show that R&D relief claimed by small and medium sized companies (SMEs) is increasing, it seems that many eligible smaller companies are still not claiming the relief. This is often due to a lack of awareness, or a misunderstanding of the requirements for relief.

The aim of this article is to dispel some common misunderstandings around R&D relief for SMEs and highlight some points which can help readers identify the potential for, or improve the quality of, R&D claims for their clients.  It looks solely at the SME R&D scheme and does not consider R&D relief for large companies (which operates under a different regime).

I don’t think my clients carry out R&D

The definition of R&D for tax purposes is fairly wide – it’s not just lab coats and test tubes.  This means that some activities may be classed as R&D which might not, at first glance, qualify.

The official definition set out in the Department for Business, Energy & Industrial Strategy’s (BEIS) Guidelines is that R&D takes place for tax purposes when a project seeks to achieve an advance in science or technology through the resolution of scientific or technological uncertainty.

This definition means that, as well as scientific research, R&D can also include development work and design and engineering that involves overcoming difficult technological problems – for example, creating new products or processes or improving existing ones.  In addition, the following may also qualify as R&D:

• Attempts to replicate a particular advance in science or technology which has already been made or attempted but where the details are not readily available (for example because it is a trade secret) – but not routine copying, analysis or adaptation of an existing product, process, service or material.
• Work which takes place alongside production which seeks to improve, optimise or otherwise resolve uncertainties.
• Unsuccessful projects – R&D can still take place where the advance in science or technology sought by a project is not achieved or fully realised – indeed, that demonstrates the existence of uncertainty.

The company is too small for a claim to be worthwhile

There is no minimum or maximum level for an R&D claim (save for an overall cap of €7.5m on total state aid received per project under the SME scheme).  Provided all of the qualifying conditions are met, and that the company incurs qualifying expenditure, then relief can be claimed.

Relief is given to SMEs by means of an enhanced deduction.  This is currently set at 130% of the qualifying expenditure, and is in addition to the normal deduction available, meaning that for every £100 of qualifying spend, an SME can deduct £230 for corporation tax purposes.

Even if a company is loss making, it is still worth making a claim.  If an SME claims an enhanced deduction and makes a trading loss they can surrender all or part of that loss for a payable tax credit equal to 14.5% of the trading loss. However, it should be noted that, at 14.5%, the rate applied in calculating the credit is lower than the corporation tax rate (currently 19%).  Therefore, if there is no immediate cash need but there is a good prospect of future profits, it may be preferable to carry the loss forward.

The company doesn’t have enough qualifying expenditure on R&D

A fairly broad range of expenditure can qualify for R&D relief.  In addition to the more obvious costs such as those of employing dedicated R&D staff and consumables used during R&D, the following items may also qualify for relief:

• Staff costs arising from qualifying indirect activities (these include maintenance, security, administration and finance and personnel activities insofar as undertaken for R&D).
• Utilities such as water, fuel and power.
• Software employed directly in carrying out the R&D or in carrying out qualifying indirect activities.
• Externally provided workers supplied through a third party staff provider such as an agency.
• Contracting out R&D to another party.

If staff costs, software, utilities or other consumables are only partly incurred in respect of R&D an apportionment may be necessary.  It should be noted that, generally, only 65% of payments for externally provided workers or subcontracted R&D will be eligible for relief (unless the payments are made to a connected party or an election for connected party treatment is made).

For expenditure to qualify for R&D relief, it has to be deductible as a revenue expense and therefore not capital in nature or otherwise disallowable.  However, if a company has spent any money on plant and machinery used for R&D purposes then it may be possible to claim a 100% R&D allowance under s437 CAA 2001.

Further information

This article is only a brief summary of points to consider. If you think a client may qualify for SME R&D relief, it is worth doing some further research.  A recently published technical article on the ATT website provides more detail on the definition of R&D, qualifying expenditure and how to make a claim as well as providing links to guidance from HMRC.

Finally, if the company is small (turnover of £2m or less and fewer than 50 employees) and has never before made a claim for R&D relief, you may wish to consider taking advantage of HMRC’s Advance Assurance facility.  This enables companies or their agents to contact HMRC in advance of submitting a claim for R&D relief and get confirmation that the activities they carry out will qualify.  The main advantage is that, if advance assurance is received, the SME’s claim will be accepted without further enquiry for the first three accounting periods provided that it is in line with what was discussed and agreed during the application process.