R&D Tax Relief, R&D Tax Credit - Know it all

To reward UK companies on innovation; the government offers Tax Relief on Research and Development (R&D) projects.

However, there are tenacious steps about the applicability of claiming this worthy R&D Tax Relief. These steps are either based on the qualification criteria or the process of claiming the R&D Tax Relief.

The reality is that this relief is far more widely applicable than many believe, can be secured efficiently with the right guidance, and continues to be hugely valuable to UK businesses who invest in innovation and R&D.

While companies continue to develop and innovate new products, they need a system in place that cuts down the effort required to capture the qualifying R&D activity and related expenditure so that they can make the most of the claim for R&D Tax Relief.

In this article we explore the qualification criteria and the process to shed some light on how companies can get benefitted out from this scheme.

Background

R&D Tax Credit, a UK tax incentive designed to encourage companies to invest in R&D, was introduced in 2000 for small and medium enterprises (SMEs), with a separate scheme for larger companies launched in 2002.

The R&D incentives have been enhanced in recent years to encourage and reward greater innovation in the UK.

Companies can reduce their tax bill or claim payable cash credits as a proportion of their R&D expenditure. Any company carrying out R&D is likely to qualify for the R&D Tax Relief. The definitions of eligible R&D and eligible costs are reasonably broad, and eligible R&D activities often take place across the whole range of company operations.

The rationale behind the UK government increasing the R&D base by helping to reduce the cost of corporate R&D was to encourage companies to invest more in R&D. In turn, this would increase innovation and wealth creation in the economy.

Many other countries worldwide like Canada, France and the USA already operate schemes to promote corporate R&D investment.

The UK Government has set up R&D Consultative Committee, a Working Group to supplement the public consultation already in progress. Members of this group include representatives from Her Majesty’s Revenue and Customs (HMRC) and Her Majesty’s Treasury (HM Treasury) and agents, professional bodies, delegates from the industry as well as the primary business, technical and trade bodies. Other HMRC representatives and members from other governmental departments also participate.

Why are companies missing out?

Around two thirds of eligible companies have never made an R&D Tax Relief claim. This is mainly because there are several misunderstandings.

To start with, it is hard to believe that failed innovations can still reward companies and can provide extra capital which can be reinvested. Statistics released each year by HMRC show hundreds of claims made in sectors as varied as administration and support services, construction, transport and storage, arts, entertainment and recreation, education, health and social work, finance and insurance.

Here are the assumptions that stop companies from claiming R&D Tax Credit.

Applies only to large companies

The R&D Tax Relief is available to companies of all sizes and can be more beneficial to small and medium sized enterprise (SME). What scheme the company uses to make an R&D Tax Credit claim will largely depend on if the company is an SME or a large company.

SMEs are defined as companies with fewer than 500 staff and either not more than €100 million turnover or €86 million gross assets, including start-ups.

Large company are companies with 500 staff or more and either more than €100 million turnover or €86 million gross assets.

The SME R&D Tax Credit scheme is applicable for SMEs. Large companies can use the Research and Development Expenditure Credit (RDEC).

While employee numbers, turnover and assets are the key criteria for SME classification, the test is based on an EU recommendation and can be complex.

Applies only to scientific R&D or high-tech product development

This assumption that R&D applies only to scientists is very common, though completely wrong.

According to the ‘Making R&D easier for small companies’ guide: For tax purposes, R&D takes place when a project seeks to achieve an advance in overall knowledge or capability in a field of science or technology.

The R&D clause refers to innovation in many forms across all sectors. Whenever a technical challenge occurs where skilled personnel cannot identify a sure route to the solution their attempts to solve, whether successful or not can qualify.

The R&D definition is far broader than many people think and encompasses most complex development work, including software development, particularly where there is experimentation, prototyping and testing. Related indirect activities such as project management can also be included.

The scheme is not restricted only to product development, but also applicable to process development, process improvement, repetitive quality issues, root cause analysis / resolution and many others.

The HMRC R&D criteria have been kept wide, on purpose. Companies taking a risk by trying to resolve scientific or technological uncertainties qualify for the R&D Tax Credit claim.

It’s fair to note that the scheme is not applicable to projects working within a social science like economics or a theoretical field like pure maths.

Competitor already overcoming the problem

The claim is not valid if a competitor has already overcome the problem.

If the method or process by which company’s competitor, or some other company working in a different sector arrived at the solution is unknown, unsuitable for the company’s product or protected by patent, the activities can still be eligible.

The process, product or service can still be an advance if it’s been developed by another company but is not publicly known or available.

Work done using existing technologies that involves overcoming constraints, applying them in a different way, or a way where the solution is not clear, can also be eligible.

If you make losses, you can’t benefit from the R&D Tax Relief.

From the perspective of the R&D Tax Relief, R&D doesn’t necessarily have to have been successful to qualify and claims can be made for two years from the end of the tax year in which the work takes place. R&D tax credits can help to reduce a limited company’s corporation tax bill or be claimed as a cash sum reimbursement from HMRC if the company is loss making.

Companies of all sizes can now claim their R&D benefit as a cash credit where they are loss making, but the wider tax implications need to be considered, such as interaction with losses brought forward or surrendered by other group companies.

The human resource is just a minute proportion

The human resource cost claimable is just a minute proportion of the overall project costs.

Whilst in some cases this can be true, it is usually the case that a far greater proportion of project activity will be eligible.

The human resource costs that qualify for R&D Tax Credit are:

• Staff, including salaries, employer’s NIC, pension contributions and reimbursed expenses.
• Subcontractors and freelancers.
• Payments to the subjects of clinical trials.

Other ticks in the boxes

There are a few more points that need to be covered by the company wanting to submit a claim for the R&D Tax Credit before jumping to the process of submitting the claim.

Showing that the project is within the tax definition

Companies must reflect on what scientific or technological advance is being pursued, rather than focusing on the product, process or functionality being developed. The focus needs to be on the project’s aim for an advance. It’s not enough that a product is commercially innovative. Companies can’t claim in respect of projects to develop innovative business products or services that don’t incorporate any advance in science or technology.

The companies also need to show that there was uncertainty. Scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice, isn’t readily available or deducible by a competent professional working in the field. But uncertainties that can be resolved through relatively brief discussions with peers are routine uncertainties rather than technological uncertainties. Technical problems that have been overcome in previous projects on similar systems aren’t likely to be technological uncertainties.

The company needs to introspect on how and when were the uncertainties overcome and why wasn’t the knowledge being sought readily deducible by competent professionals. The company must explain the uncertainty in the context of the known state of the field of research.

If there’s little public information available about the project, the company needs to show that the people leading it are competent professionals working in the relevant field. This might be done by outlining their relevant background, professional qualifications and recent experience and then have them explain why they consider the uncertainties are scientific or technological uncertainties rather than routine uncertainties.

Work out when the R&D activity starts and ends

The R&D activity starts when the company begins working to resolve the uncertainty. The company needs to identify the technical issues that need to be resolved, and make sure there is not an existing solution that has already been worked out.

The R&D activity ends when the company solves the uncertainty or stop working on it. The activity claimed for R&D Tax Relief must end once a working prototype that solves the problem, and before it goes into production.

The R&D may restart if the company finds another scientific or technological uncertainty after starting to produce the product. In this case, the company can claim for further R&D while it tries to resolve it.

What costs qualify for R&D Tax Credit?

Direct and externally provided staff, subcontracted R&D, consumables, software, trials, prototyping and independent research costs may all qualify for R&D Tax Relief. Capital expenditure does not qualify under this scheme, nor does expenditure on the production and distribution of goods and services.

Essentially, the following types of R&D qualifying expenditure:

• Staff, including salaries, employer’s NIC, pension contributions and reimbursed expenses.
• 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.
• Payments to the subjects of clinical trials.

Not all costs qualify though. The company cannot receive R&D Tax Relief for:

• The production and distribution of goods and services.
• Capital expenditure under either of the R&D Tax Relief schemes. However, a generous 100% Research and Development Allowance may be due on capital assets, such as plant, machinery and buildings used for R&D activity.
• The cost of land.
• Payments for the use and creation of patents and trademarks, as these are the cost of protecting the completed R&D. This also includes the staff costs in relation to the time spent by all staff on the preparation and submission of such applications.

Grants or subsidies that the company receives for the R&D project may make a difference to the R&D claim. The company may have received a grant which is not a notifiable State Aid — examples include de minimis State Aid, Horizon 2020 or Framework Programme funding, and the company may be eligible to claim under both the RDEC and the SME scheme.

The last stride – how to claim

The company can make a claim for R&D Tax Relief up to 2 years after the end of the accounting period it relates to. This can be done by entering the enhanced expenditure into the full Company Tax Return form (CT600).

To calculate the enhanced expenditure, the company needs to:

• Work out the costs that were directly attributable to R&D.
• Reduce any subcontractor or external staff provider payments to 65% of the original cost.
• Add all costs together.
• Multiply the figure by 130% to get the additional deduction to put into the tax computations.
• Add this to the original R&D expenditure figure to get the enhanced expenditure figure which can be entered in the tax return.

If there is a trading loss, the company can choose to surrender this and claim R&D Tax Credit.

The online service can be used to support the claim.

Following are the details that are needed to support the claim

• A short summary with points confirming
  • Looked for an advance in science or technology and aimed to achieve this advance
  • Had to overcome scientific or technological uncertainty
  • Overcame this uncertainty
  • Could not easily be worked out by a professional in the field
• The start and end dates of the accounting period relating to the R&D activity – these should be the same dates as the period covered by the CT600 return
• Ten-digit company unique tax reference (UTR) number
• The total amount of tax relief claiming
• Breakdown of the qualifying R&D costs
• Unrelieved trading loss for the claim period

Innovation could be that key ingredient for companies to accelerate or boost business growth without the constant need for new sales or new customers. However, Innovations usually require significant time and financial investment before they become commercially viable. So, although not all innovations will prove to be successful, it’s good that they can bring rewards that can benefit the company’s bottom line.