Will your innovative project qualify as Research and Development and earn you a tax saving/rebate?
The UK government have for the last 20 years supported companies that work on innovative projects in science and technology.
HMRC have their own definition of Research and Development (R&D) – if your project(s) meet the definition you could be due a significant reduction in tax and/or a payment from HMRC.
Below we look at:
- What is R&D for tax purposes
- The SME R&D relief scheme
- The RDEC scheme for sub-contractors to large companies
- What counts as qualifying expenditure
- Timeline of the project
- Implication of receiving state aid on the project
Projects that count as R&D
- The R&D project must relate to the company’s trade – existing trade or that intended based on the R&D
- There needs to be a project specifically identified to make an advance
- Note that it does not need to have been a successful outcome! Innovation comes with experiment - and this tax relief scheme recognises that not all projects will lead to success - the costs involved in the attempt can be included in a claim
HMRC will ask you to explain how the project(s);
- Looked for an advance (extended overall knowledge or capability) in a field of science and/or technology (not just extending the company’s own knowledge or capability)
- Had to overcome an uncertainty in the field
- Overcame or tried to overcome this uncertainty
- Could not easily be worked out by a competent professional in the field
The R&D project may research or develop a new process, product, device or service or appreciably improve upon an existing one.
Here are a few HMRC examples that may help to explain the type of innovation that would qualify for the SME R&D relief scheme:
ICT: A company realised that each object on a game’s screen had to be programmed in respect of its interaction with all the other objects. As the game became more complex, more objects were introduced and the amount of code required rose exponentially. The solution was to programme the properties of each object. When the objects interacted, a separate code was no longer required as the inherent properties produced the outcomes. The qualifying expenditure on developing this innovative code qualified for R&D relief.
Advanced materials: A company, specialising in agricultural engineering, used a probe to provide information on the quality of cereals which were transported in sacking. Measurements could only be taken at the top, as anywhere else would damage the sacking. This however did not produce representative samples. The company designed a material which allowed a probe to enter the sacking and which reverted to a sealed surface once the probe was removed. Although the market for this material was limited, it proved extremely successful in overseas markets. For R&D purposes the company incurred qualifying expenditure in overcoming the uncertainty in developing the material.
Advanced engineering: A project is commissioned to produce a prototype (not to be sold) that will test a design for a new eco-petrol engine and exhaust. The goal is to achieve a substantial reduction in eco-unfriendly emissions with a performance at least as good as a comparable engine. This appears to competent professional engineers to offer hope of achieving a real advance by way of an improvement in vehicle technology. The uncertainty in science and technology is whether this substantial reduction with the comparable performance sought is possible. Even if unsuccessful, this and the construction of the prototype is still a qualifying R&D project.
Construction: A company created a cladding system which had the appearance of ‘normal’ brickwork but incorporated the capacity for off-site fabrication, improved fire protection and suitability to fast-track production. Mechanical fixing rather than wet mortar provided strength and durability, which together with the capacity to construct in all weather conditions provided significant cost savings. The uncertainty of the materials in the cladding system and the technological uncertainties surrounding fixing were qualifying R&D projects.
Two types of tax relief are relevant to the SME* business community:
The SME R&D relief scheme
Where an SME directly carries out the qualifying R&D project(s) they can claim under this scheme
- It allows the deduction of a further 130% of qualifying R&D costs
- If in loss, or the claim of the deduction creates a loss – the scheme allows for a payment of 14.5% of the surrendered loss
Innovators Ltd have a profit of £35,000 for the tax year – and qualifying R&D project expenditure of £30,000.
The company can claim an additional £39,000 (£30,000 x 130%) of costs under the SME tax relief scheme – removing the need to pay any Corporation Tax for the year (Saving £6,650) – in addition they will receive a payment of £580 (£4,000 x 14.5%) by surrendering the resulting loss of £4,000 (£35,000 profit less enhanced expenditure of £39,000). The total savings for the company are therefore £7,230 (£6,650 plus £580).
Restrictions to be aware of are:
- If any state aid has been received it may impact the claim
- The company must be a going concern ie be able to meet its future obligations
- The credit can be set against other owed taxes by HMRC
- Will not be credited if the company is under a tax enquiry for the Accounting Period of the claim
The Research and Development Expenditure Credit (RDEC) scheme
Generally where an SME sub-contracts to a large company, or body in the UK not chargeable to tax, they can claim under this scheme.
Recently the rate of claim was 12% of qualifying expenditure.
From 1st April 2020 this has been increased to 13%.
So for every £100,000 of qualifying expenditure you can now receive a £13,000 tax credit in your tax return.
*an SME for the purposes of R&D tax credits is one with either i) sales less than Euro 100m or ii) net assets of less than Euro 86m – this will include group and connected companies and partners – ask for more information if needed.
What counts as qualifying expenditure?
Project costs can include the following:
Salaries/Wages/Class 1 NIC/Pension fund contributions
For directly attributable staff – or a portion of costs where time is split
Include a portion of clerical staff directly attributable eg an HR recruiter who recruits for the R&D project
65% of agency staff payments where the staff work on the R&D project
65% of sub contracted staff payments where the staff work on the R&D project
Software costs – directly related to the project or a reasonable share of other software used in the business (use % of payroll costs as a fair approximation)
Consumables – such as materials and utilities – again apportion where necessary
Building of a 'not for sale' prototype
Clinical trial volunteer payments where applicable (pharma)
Production and distribution costs of products, devices and services
Capital expenditure (but see other incentives such as the Annual Investment Allowance)
Cost of land
Cost of securing patents and trademarks
Rent or Rates
Clerical costs of staff where required anyway – eg payroll staff
Remember to deduct the Employers Allowance from the claim if applicable
Be clear about when a project starts and ends for R&D tax relief purposes
The project begins when you start work to resolve the identified uncertainty.
The project ends when you give up or complete a working prototype – ie usually when you start pre-production design.
You can only claim costs for the portion of time that the project was active in an R&D stage.
Notifiable state aid
If your company is already receiving grants for the R&D project this could impact the claim - it depends on the type of grant/aid being received.
Reach out to a professional if this is a consideration in your claim.