A handy guide to R&D, including worked examples and reflecting the impact of Covid-19.
Research & Development (R&D) tax relief provides financial tax incentives when companies take the risk to advance, develop, modify or improve a product, service, process or solution despite the uncertainty of the outcome. Eligibility is not dependent on whether the project is ultimately successful.
Two schemes are available depending on the size of the company:
- Small or Medium-sized Enterprise (SME) Scheme for small companies
- Large companies fall under the Repayable Credit Large Company Scheme or R&D Expenditure Credit (RDEC) for large companies.
An SME is a company with fewer than 250 staff and a turnover of under €50m or a balance sheet total under €43m.
SMEs
From April 2020 SMEs are entitled to deduct the total of 230% of actual research costs expensed (of revenue nature) to reduce their taxable profit or create an augmented surrenderable trading loss and obtain a 14.5% tax credit. Tax relief for capital costs follows a capital allowances regime (RDA) and is not within the scope of this article.
Example (per Tolley guidance)
SME Ltd has the following results for the year ended 31 March 2020:
| Trading loss | £170,000 |
| Qualifying R&D expenditure | £45,000 |
The surrenderable loss is the lower of:
- £170,000
- £45,000 x 230% = £103,500
The tax credit given will be 14.5% x £103,500 = £15,007.50.
This tax credit of £15,007.50 will either be used to reduce company’s corporation tax bill if it has other sources of income or to discharge any outstanding PAYE and NIC (or indeed VAT) liabilities for the period. Any remaining tax credit will be received as a tax-free refund.
The trading loss of the company carried forward is now £170,000 – £103,500 = £66,500.
Large companies
Large companies currently obtain tax relief via research and development expenditure credits (RDEC) only. Previously, for three years between April 2013 and April 2016 large companies had an option to claim an enhanced deduction of 130% or irrevocably elect for RDEC.
A RDEC is taxable (above the line credit) and its amount depends on when R&D expenditure was incurred. Companies qualify for:
- 13% credit for expenditure incurred on or after 1 April 2020
- 12% credit for expenditure incurred from 1 January 2018 to 31 March 2020
- 11% credit for expenditure incurred from 1 April 2015 to 31 December 2017
- 10% credit for expenditure incurred from 1 April 2013 to 31 March 2015.
As an anti-avoidance measure, any cash credit is capped at the total of PAYE and NI paid in respect of the staff whose costs form part of the qualifying expenditure of the claim. If there are insufficient PAYE/NIC liabilities, the credit can be carried forward and utilised in later years.
Example (per Tolley guidance)
Large Ltd has trading profits of £5,000,000 for the year ended 31 March 2020 before deducting R&D expenditure of £1,500,000. The R&D expenditure is qualifying expenditure for the purposes of RDEC. The company claims RDEC relief and its corporation tax computation is as follows:
|
£ |
|
| Trade profits before R&D expenditure |
5,000,000 |
| Qualifying R&D expenditure |
(1,500,000) |
|
3,500,000 |
|
| RDEC (£1,500,000 x 12%) |
180,000 |
| Trade profits |
3,680,000 |
| Corporation tax at 19% |
699,200 |
| Deduct RDEC |
(180,000) |
| Corporation tax payable |
519,200 |
Costs which qualify for R&D claim
- Costs must be relevant to trade already carried on by the company although it is possible to claim pre-trading expenditure as an immediate loss for relief (or tax credit) if election is made in writing within two years of the end of the accounting period.
- Costs in relation to staff actively carrying out R&D or on qualifying indirect activities apportioned to the R&D function such as maintenance, administration and clerical activities in relation to direct R&D activities. For example, reports prepared by a PA on testing outcomes of a research test will qualify as an administration cost in relation to a direct R&D activity. A report on lab equipment maintenance requirements prepared by a PA will not be a qualifying cost as the activity supports an indirect function of lab maintenance.
- HMRC is likely to reject claims where 100% of staff expenditure has been claimed, even for direct R&D staff, due to the assumption that all staff take breaks during standard working hours.
- Broadly, 100% of externally provided and subcontracted worker cost if the claimant company is connected with the subcontractor, and 65% if the work is subcontracted to an unconnected party. SMEs may elect for a connected party treatment and in some cases such an election may be beneficial. Provisions relating to R&D claims when R&D is subcontracted are complex and depend on multiple factors.
- Materials and consumables used in carrying out R&D activities, excluding those sold in normal course of business.
- Payments to volunteers of clinical tests if amounts are relevant payments.
- Utilities including power, water, fuel used directly in carrying out R&D, excluding telecoms and data. Costs of electricity if supplied to mixed-use building must be proportioned.
- Software used directly in R&D or apportioned if used also for non-R&D activities.
Other red flags to look out for when preparing a claim
Subsidised R&D costs
- Where a company obtains state aid subsidies such as government grants, SME tax relief is denied, and the company may only claim RDEC, even if the grant itself is used for other purposes than the R&D project.
- CJRS grants qualify as subsidies and a company which obtained the grant does not qualify for the SME R&D scheme. RDEC claim can be made but CJRS grant receipts must be excluded from the claim. To the extent the furlough payments were met by the employer, rather than via the CJRS, and some qualifying activity was still carried out during the furlough period (once the CJRS allowed part time work), an appropriate proportion of employer staff payments may be included in a claim.
Going concern impact on R&D claim
- Where a company is not a going concern, its audit report has been qualified on the basis of going concern or would be qualified but for the expected R&D credit or if the company has gone into liquidation, no R&D tax relief can be claimed.
Exceeding R&D expenditure cap
- If the total combined value of an R&D claim per project exceeds €7.5m, only RDEC and not SME relief can be claimed.
Restrictions when subcontracting R&D
- If a large company or an entity outside the scope of UK tax subcontracts work to an SME – SME relief is denied but RDEC can be claimed.
- If an SME subcontracts R&D work to a large company – SME, rather than the large company, claims the relief.
Evidence that R&D costs have been incurred
- A claim can be made for expenses actually incurred and paid.
In Teksolutions-Inc v HMRC [2019] TC745, a company’s R&D claim was rejected in full as the company failed to prove that it had incurred and paid expenses claimed. The company could not provide bank statements or other documentary evidence to justify the claim.
This article has been shared from ACCA In Practice, to whom copyright belongs. Whitefield Tax are an ACCA Member Firm