Research and development (R&D) tax credits can potentially offer small and medium-sized enterprises (SMEs) a lucrative form of corporation tax relief.
That said, many SMEs who have made capital investments in innovative projects that would qualify for R&D relief, are failing to take advantage of the available tax reductions or cash payments available.
There may be a number of reasons for this lack of uptake, not least the perceived complexities involved in the following:
- identifying qualifying activities
- identifying qualifying expenditure
- calculating the amount of available relief applying the relevant rate
- justifying a claim to HMRC.
It is also often the case that many businesses are simply unaware of the availability of research and development tax credits, or that their company can qualify for SME R&D relief, in the first place.
Below is a simple guide to understanding research and development tax credits for SMEs, from who can claim to how to submit your final calculations.
Does my project qualify for SME R&D relief?
Research and development tax credits are designed to recognise and reward scientific or technological innovation. As such, to qualify for R&D relief, your project must satisfy the following criteria:
It must be part of a specific project to make an advance in science or technology, excluding work relating to the social sciences.
It must fall within your particular field of work, although this extends to a proposed area of work that you intend to start up, based on the result of the research and development undertaken.
Your R&D project can include creating new processes, products or services, improving existing ones, or even using science and technology to duplicate existing processes, products and services in a new way.
Does my company qualify for SME R&D relief?
R&D relief is open to companies across all sectors, where it is the nature of the innovative project rather than the nature of the business itself that must meet the ‘research and development’ requirements.
However, to specifically qualify for SME R&D relief you must:
- have less than 500 staff
- have a turnover under £100m or a balance sheet total under £86m.
The staff, turnover and balance sheets of any linked or partner companies should be included in your total when you work out if you qualify as an SME.
In circumstances where the criteria for the SME R&D scheme has not been met, your business may still be eligible for relief under the alternative Research and Development Expenditure Credit (RDEC) scheme.
SMEs may also claim relief under the RDEC scheme where they are prevented from using the R&D SME scheme because of a grant or subsidy, or because they are carrying out subcontract R&D for a large company.
What constitutes qualifying SME R&D expenditure?
Broadly speaking, you can claim research and development tax credits for the day-to-day operational costs directly relating to the R&D project. This can include:
- staffing costs
- externally provided workers
- consumables & utilities
- software directly used in the project
- clinical trial volunteer costs.
However, you cannot include any capital expenditure, although a separate tax allowance may be available on any capital assets such as plant, machinery or buildings used in the R&D project.
The cost of production and distribution, land, and the use and creation of trademarks and patents are also excluded.
How do I calculate a claim for SME R&D tax credits?
The level of relief available depends upon which of the two schemes your company uses. The R&D SME scheme offers more generous rates than the RDEC scheme, intended primarily for larger companies.
The relief a company can claim under the SME scheme is 230% on qualifying R&D costs. If you make a trading loss, you can choose to surrender this and claim a payable tax credit instead.
Under the RDEC scheme, a taxable credit is available at just 12% of qualifying R&D expenditure (with effect for expenditure incurred on or after 1 January 2018.).
How do I claim the right amount of SME R&D relief?
It is important to know when an R&D project starts and ends, because that will help to ensure that your company claims the right amount of relief.
You can claim qualifying costs on your R&D project from the date you start working on the scientific or technological uncertainty, until you develop or discover the advance, or the work to resolve it ceases.
Where the project is a success, the activity you claim R&D relief for should end once you have a working prototype that solves the problem, and before you go into production.
Will a grant or subsidy affect my SME R&D claim?
If your company has received a grant or subsidy this could affect its eligibility for research and development tax credits.
The R&D SME scheme is what’s known as a notifiable state aid, whereby a company cannot benefit from the tax relief provided under this scheme if it is receiving any other notifiable state aids for the same R&D project.
However, you can instead claim for eligible expenditure that has been subsidised by the grant or subsidy under the RDEC scheme, and you won’t need to reduce the RDEC eligible expenditure by the value of the grant received.
Any expenditure not covered by the grant or subsidy can also still be claimed under the SME R&D scheme.
How do I submit a claim for SME R&D tax credits?
Any claim for research and development tax credits can be made by entering the total qualifying expenditure on your Company Tax return form (CT600).
You should show a breakdown of your total expenditure and how these costs were apportioned to the R&D project, for example, the percentage of total staff costs. For SMEs that subcontract qualifying R&D activities, you can claim tax relief on 65% of the payment to the subcontractor.
If your company has been undertaking qualifying research and development and has not yet claimed R&D relief, you may make a backdated claim. Typically, you have two years from the end of your accounting period to which the R&D relates to submit a claim for relief.
What additional information should be provided?
Any CT600 claim for research and development tax credits should be supported by a short technical report, to include a summary of the R&D project undertaken and how this falls within the relevant definition.
The nature of the information to be included will vary depending on the type of scientific or technological work involved, but generally this report should explain how your project:
- looked for an advance in science and technology
- had to overcome uncertainty
- overcame this uncertainty
- could not easily be worked out by a professional in the field.
You should therefore focus on the advances being sought and the uncertainties faced, rather than just a description of the finished product.
The report, whilst technical in nature, should be written in a way that can be understood by someone who is not an expert in that field.
Key takeaway for R&D tax credits
Research and development tax credits are designed to recognise and reward innovation by reducing your company’s tax bill. That said, the onus is on you to correctly submit and support a claim to HMRC.
Understanding how research and development tax credits work can help you to successfully claim the tax relief to which your company is entitled.
That said, where your SME has made a significant capital investment in an innovative project, seeking professional advice from a financial specialist will help you to maximise the value of your claim.