R&D Tax Credits Explained

R&D tax credits gives enhanced tax relief to companies that spend money on new systems, products or services.

The research and development tax credits scheme is ran by the government and aims to promote companies’ investment in scientific and technological research and development projects.

R&D stands for research and development and increases your company’s development costs which, in turn, reduces your taxable profits and your corporation tax bill.

If your company qualifies but makes a loss the research and development tax relief can be claimed back as an R&D tax refund.

The potential for recognising R&D qualifying for tax credits spans almost every sector but can only be claimed by organisations with a limited company status registered for corporation tax.

You can claim R&D tax relief on an annual basis as long as your research and development projects fall within the parameters of eligibility.

Choosing the right R&D tax credit scheme for your company

The R&D scheme is divided into two partly depending on the size and profitability of your company.

If you are an SME, it is essential to determine whether you qualify for the R&D merged scheme or R&D intensive scheme.

The merged R&D expenditure credit and enhanced R&D intensive support schemes will take the place of the previous RDEC and SME schemes for accounting periods starting from 1 April 2024 onwards.

For initial R&D claims it is usually possible to request R&D tax relief for your two most recent completed accounting periods and the company must not be in liquidation or administration when the claim is filed.

The tax advantage will be independent of a company’s profit or loss situation with the value based on the total tax credit minus corporation tax on that credit.

How does the merged R&D tax credits scheme work?

Starting from 2024/25 tax year the merged R&D scheme brings together the previous SME and RDEC tax credit schemes.

From April 2024 onwards, the SME R&D tax relief scheme will be discontinued for SME’s unless classified as ‘R&D intensive’. All businesses will then file claims under the new merged R&D regime.

The merged research and development expenditure credit is a taxable credit that can be claimed by qualifying trading companies.

Small and medium sized enterprises that are not heavily focused on research and development but have eligible R&D expenses can apply for relief through the merged scheme.

Depending on whether your company is in profit or loss making you can claim an R&D tax credit which can result in a cash refund or a reduction in corporation tax.

The credit for research and development expenditure is subject to corporation tax because it’s classed as taxable trading income.

A gross taxable credit will constitute 20% of the eligible R&D expenditure and is recorded as income within a company’s financial statements.

Given that this income is subject to tax, the net (cash) benefit to claimants will be the gross credit minus the corporation tax on that credit.

When you subtract your enhanced expenditure from your taxable profits, or add it to your loss, it will either lead to:

• a reduction in corporation tax if you are making a profit.

OR

• a cash credit if you are operating at a loss.

For R&D tax credit purposes a company is classed as an SME if they have up to 500 employees and either an annual turnover up to £100million euros or a balance sheet reaching £86million euros.

What are merged R&D tax credits worth to SME’s?

Companies with expenses qualifying under the merged R&D tax credit scheme receive a credit with a rate set at 20%.

The value of the R&D credit is worth 20% of the allowable expenses.

The credit is liable to corporation tax which means the rate at which your company pays corporation tax matters.

• For companies with total profits liable to corporation tax of less than £50,000 (excluding the RDEC claimed) the corporation lower rate of 19% applies.
• Profits above £50,000 the corporation tax rate of 25% is used.
• For companies incurring losses, the notional tax on gross credit will be taxed at the small profits rate of 19%.

The net company gain after corporation tax is deducted:

• Companies with profits under £50,000 the net merged R&D rate is worth 16.2%.
• Companies with losses 16.2% the net merged R&D rate is worth 16.2%.
• Companies with profits over £50,000 the net merged R&D rate is worth 15%.

What is enhanced R&D intensive support?

Starting from April 2024 enhanced R&D Intensive Support or ERIS for short is accessible to loss making small or medium sized enterprises.

An SME is considered loss making if it incurs a loss for tax purposes before any extra deduction is applied.

The loss making SME (including those of any affiliated companies) qualifies for ERIS if 30% or more of its total business spending towards research and development (including those of any affiliated companies) within a specific accounting period.

This is known as the ERIS intensity condition and businesses that meet the condition can be classified as ‘R&D intensive’.

To qualify for the enhanced research and development intensive support, the intensity condition must be satisfied and typically it needs to be fulfilled for the duration of the claim period.

In instances where a company is operating at a loss and has no corporation tax obligation for the accounting period, a hypothetical tax deduction (equivalent to the corporation tax on the credit at the main rate) is retained.

If after the enhanced relief is claimed your SME is loss making – you can either carry the loss to the previous 12 months or carry it forward against future trading profits.

Or under specific rules, you can surrender the loss to HMRC and claim cash credit at a current rate of 14.5%.

What are enhanced R&D Tax credits worth to SME’s?

ERIS will allow a further deduction (R&D enhancement) for qualifying R&D expenditure equal to 86% which effectively increases the company’s trade loss by that amount.

• Subject to the PAYE cap, a tax credit can be secured by surrendering the lesser of the actual loss during the period or 186% of the R&D expenditure (the enhanced R&D expenditure).
• The ERIS tax credit amounts to 14.5% of the surrenderable loss which isn’t considered taxable income.

Depending on the starting loss position before considering the R&D enhancement, ERIS could be worth between 12.47% and 26.97%.

Example: You have £50K profits and R and D qualifying expenditure of £100K. The enhanced expenditure is £130K, resulting in an 80K tax loss.

• The £80k figure calculated from this comparison is termed the ‘surrenderable loss’.
• Surrendering this loss at the rate of 14.5% gets you an R&D tax credit of £11,600.

What is the PAYE cap for R&D tax relief?

The PAYE cap for claims under both the integrated scheme and ERIS is set at £20,000 plus 300% of the company’s applicable PAYE and national insurance contributions liabilities.

Any amount exceeding the PAYE cap can be carried forward to future periods unless the company is exempt from the cap.

For the merged R&D scheme the PAYE cap restricts the amount of credit that can be claimed during the accounting period.

Any amount exceeding this limit is carried over and considered as part of the research and development expenditure credit for the subsequent accounting period.

In the case of enhanced research and development intensive support, any tax credit claim that surpasses the cap is deemed invalid.

The PAYE cap does not apply if the company qualifies for exemption which you can learn more about in the HMRC CIRD90600 manual.

What costs can you claim for as part of a R&D tax credit claim?

You are eligible to claim R&D relief for a portion of the expenses incurred from the beginning to the completion of the R&D project. This is applicable to both ERIS and the merged research and development expenditure credit scheme.

The R&D project must be directly related to your company’s business. Your company may already be up and running or it may be one you are going to start once you have the conclusions of the research.

To be eligible the R&D project must have “the resolution of scientific or technological uncertainty” as its aim. It cannot be just advancement; it must intend to resolve an existing “uncertainty”.

It is worth noting that science does not include social sciences, economics, humanities or the arts.

HMRC states “R&D starts when work begins to resolve the scientific or technological uncertainty and ends when that uncertainty is resolved, or the work to resolve it stops.”

Basically you must be able to prove that any elements that are “directly and actively engaged in research and development activities” (HMRC) and include:

• Utilities – fuel, water, power
• Software– specific to the project development including data storage, hardware facilities, operating systems and software platforms.
• Data licence
• cloud computing
• Subcontractor – if you hire a subcontractor to do some of the R and D work then you could be eligible to claim back 65% of this cost.
• Capital expenditure – If you spend on capital assets as part of your project you may be able to claim R and D Capital Allowances.
• Staff providers – if they have a contract with the individual employees they provide you with.
• Staff – employees your business directly employs; not consultants, people who are contracted to other companies or agency workers.
• Materials – the physical ‘stuff’ you need for your project work.
• Clinical trials – payments to volunteers in clinical trials
• Not all costs qualify for R&D tax credits
• HMRC gives some of the following examples of costs that aren’t eligible:
• Rent
• Business rates
• Leasing
• the cost of land
• capital expenditure
• production of goods and services
• distribution of goods and services
• Trademark and patent acquisition

What evidence do I need for an R&D tax credit claim?

HMRC advise businesses to include the answers to four questions within their claim, in order to clarify the R and D project’s eligibility.

Some of the popular questions you may need to provide an answer for include:

What is the scientific or technological advance?

Not just the end product or process that the project is researching, but clearly states the advancement within the aims of the project.

What were the ‘uncertainties’ you were investigating during the project?

So, is the subject of the project possible? Can the answer be found in your field? If not, then you have technical or scientific uncertainty and you need to explain this in layman’s terms as part of your application.

When and how were these uncertainties resolved?

Here HMRC are looking for a short summary of your methods and analysis which demonstrate the complexities involved in your project. A conclusion about the success or failure to resolve the initial uncertainty is also necessary.

Why didn’t you find the necessary information from another professional?

There may be no available information about your project’s subject, in which case your project’s leaders must be identified as “competent professionals” with a summary of their qualifications and experience.

They must also submit an explanation of why they feel there is a technical or scientific ‘uncertainty’ involved and not simply routine research.

The key factor is that the intention of the R and D work is to make an advancement in a scientific or technological field in order to resolve an existing uncertainty. The project does not have to have a successful conclusion, nor does it have to result in the selling of a new product.

My project failed to ‘resolve the uncertainty’ – am I unable to claim R&D tax relief?

Rather delightfully, HMRC have adopted the scientific spirit of Thomas Edison, with regard to unsuccessful projects: “I have not failed 10,000 times. I have not failed once. I have succeeded in proving that those 10,000 ways will not work. When I have eliminated the ways that will not work, I will find the way that will work.”

In other words, you get R and D Tax relief even if the project fails. It is seeking innovative solutions that warrant the tax credit, not the scientific or technological achievements themselves.

He’d probably have got R and D Tax relief for every one of those 10,000 times, as well as the final successful lightbulb!

How do I claim R&D tax credits?

Companies claim R&D credit by entering the relevant figures on the full Company Tax Return form, HMRC reference CT600.

For research and development expenditure credits HMRC expects you to report the expenditure credit as taxable income in your profit and loss account or add it to your profit within the single iXBRL computations file.

For ERIS, factor in the additional deduction when calculating your adjusted trading loss in your tax computations, and make sure to exclude any losses surrendered for a payable tax credit from your loss carry forward figure.

• Mark an ‘X’ in CT600 box 656 to indicate that you have submitted the claim notification form.
• Mark an ‘X’ in CT600 box 657 to indicate that you have submitted the additional information form.
• Complete the supplementary form CT600L if you are claiming expenditure or payable R&D credit as an SME.
• Don’t forget to provide your bank details so HMRC can process the payment.