R&D tax credits explained

Small and mid-sized businesses, through the SME R&D tax relief, can deduct an extra 86% of their qualifying costs from their yearly profit, as well as the normal 100% deduction, totalling a potential 186% tax deduction.

Moreover, qualifying SMEs can claim a payable tax credit if the company has claimed relief and made a loss, with the payable credit being worth up to 10% of the surrenderable loss.

To claim this tax relief, companies need to be a SME and show how their project meets the standard definition of R&D.

This enhanced incentive followed Sir James Dyson’s 2010 recommendations to government in which he warned that Britain would miss out on being Europe’s science and engineering hub if it did not act.

Guidelines designed to clear up the confusion over research and development (R&D) tax breaks came into force over 10 years ago but many business still remain unclear as to what these regulations are or how much they have to pay.

The government introduced the R&D guidelines to clarify grey areas on what innovative firms have to do to be eligible for R&D tax relief.

This was because, according to accountants, the previous complex rules governing R&D tax breaks had resulted in businesses paying too much tax when taking a risk with their business to undertake research or develop new products and services.

In addition, ignorance over the cost of taking time out for R&D had deterred some firms from starting up research at all, which the government recognised ultimately harms the economy if companies fail to lead in their industries.

However, UK small firms – whether in manufacturing, software, pharmaceuticals or other research intensive industries – can now enjoy enviable R&D tax breaks, if they can find out about them in the first place that is. Each £1 spent on R&D is now deductible at a rate of 186% for small businesses.

What are R&D tax credits and what is defined as R&D?

Small businesses are entitled to a 186% tax relief on R&D, including all expenditure on staff costs, consumables and some sub-contract costs. Qualifying companies are those with less than 500 staff and a turnover of under 100 million euros or a balance sheet total under 86 million euros.

R&D itself is defined as:

• Creative work – work of a non-routine nature which contains novel elements or outcomes.
• Undertaken on a systematic basis – this excludes one-off or ‘lucky’ discoveries. According to the guidelines, producing a novel or unique product or service isn’t in itself sufficient – it’s how such attributes arise that is important.
• Work that increases the stock of knowledge – not just the knowledge within the company. To qualify for R&D tax credits, work must result in a scientific or technological advancement.
• Within the fields of science or technology – which excludes the humanities and social sciences.

Crucially, the  guidelines state that R&D work must not “merely duplicate” what has been done before and should result in a “significant or perceptible” advance.

In brief, the guidelines define R&D as – “R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology. The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D.”

When does the tax credit period for R&D start and end?

The guidelines state that the R&D period begins when work to “resolve the scientific or technological uncertainty” starts, and ends when the uncertainty is resolved or work to resolve it ceases.

Once the R&D periods ends, problems that arise from the products or service may require fresh R&D to take place. But the guidelines are clear that there is a distinction between such problems and routine fault-fixing.

How can you apply to get an R&D tax break?

If you feel that the work you are undertaking, or plan to undertake, qualifies for R&D tax credits, it’s imperative that put an X in box 99 on your Company Tax Return and the enhanced expenditure (the amount spent multiplied by 186%) in box 101.

The enhanced figure also needs to appear in your profit and loss calculations (box 3 and 122 respectively).

There is also the option to convert the tax relief into credits. To do this you need to put the amount due to you in boxes 87, 89, and 143, as well as putting another X in the box marked ‘repayment due for this return period’ on page one.

If you’ve made a claim for repayment, HMRC will seek to verify it by opening a compliance check or ‘enquiry’. To help ensure your claim is processed it’s a good idea to provide information on why you think your the amount you spent on a project is R&D allowable.

Just like a maths test you’ll also be expected to provide your calculations, showing how the figures you’ve put in your return were arrived at. This part isn’t a legal requirement, but it may hold up your claim if you choose not to provide it.

If you’ve claimed credit, HMRC may make an interim payment before paying the balance once its ‘enquiry’ has concluded.

As the old saying goes, there is no harm in asking. If you fail to apply for R&D tax breaks, you could miss out on valuable savings, putting your entire project at risk and damaging the viability of your business.