R&D tax credits explained

Find out how your firm could benefit from the government's research and development tax breaks.

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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.

The Autumn Statement 2023: how did it affect the R&D tax relief scheme?

In the Spring Budget 2023, the Chancellor announced a loss-making SME could be considered R&D intensive if qualifying R&D expenditure was 40% of its total expenditure. Following the Autumn Statement this past 22 November 2023, this threshold was lowered from 40% to 30% of total expenditure. As part of the move, the R&D scheme has merged the RDEC and R&D SME scheme into one.

This change followed criticisms that exceptional spending could skew a SME’s intensity ration for a year, and lead businesses to move in and out of the intensive SME regime. To combat this potential uncertainty, this new provision will enable an intensive SME which has made a valid claim in the Intensive regime in one year to claim the intensive relief in year two.

Moreover, the Chancellor also announced that loss-making companies that are taxed within the R&D scheme will now have their rates reduced from 25% to 19%.

How did startups react to the changes?

“By reducing scrutiny and streamlining the process for R&D claims, the government is sending a clear message of support to innovation-driven businesses,” praises Seb Wallace, Investment Director at Triple Point Ventures. “This decision fosters an environment where companies can channel more energy and resources into what matters most – groundbreaking research and development.”

Others similarly applaud the simplification of the R&D tax scheme.

“More funding is pivotal to innovation,” welcomes James Clough, CTO and cofounder of Robin AI. “This decision particularly affects AI startups as high computing costs can make research within this sector a very capital-intensive exercise.”

For others, the R&D is still problematic in that it doesn’t offer more adequate support for early-stage startups.

“The Chancellor’s raft of announcements benefit scale-ups and later-stage companies but we are still missing genuine support for early-stage startups,” says Neil Ruth, founder of Well Cell. “Without the right support for homegrown startups, the UK risks losing huge potential from a technical, talent and economic standpoint to more startup-friendly shores abroad right from the earliest days.”

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.

Written by:
Fernanda is a Mexican-born Startups Writer. Specialising in the Marketing & Finding Customers pillar, she’s always on the lookout for how startups can leverage tools, software, and insights to help solidify their brand, retain clients, and find new areas for growth. Having grown up in Mexico City and Abu Dhabi, Fernanda is passionate about how businesses can adapt to new challenges in different economic environments to grow and find creative ways to engage with new and existing customers. With a background in journalism, politics, and international relations, Fernanda has written for a multitude of online magazines about topics ranging from Latin American politics to how businesses can retain staff during a recession. She is currently strengthening her journalistic muscle by studying for a part-time multimedia journalism degree from the National Council of Training for Journalists (NCTJ).

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