Tax Relief for Research and Development
Relief is available on Research and Development expenditure, which means that a company can claim enhanced relief on qualifying costs against its profits.
To qualify as Research and Development (R&D), an activity must be treated as R&D under generally accepted accounting practice, and fall within any guidelines issued by the Treasury. The Department of Trade and Industry (DTI) has issued guidelines on what it considers is treated as R&D for accounting purposes.
What reliefs are available?
Small and medium sized enterprises (SMEs) may claim:
- R&D tax relief – which increases the deduction to 175% of the qualifying expenditure (150% prior to 1 August 2008), or
- payable R&D tax credit – which allows companies who are not in profit to take the relief up front in the form of cash, in return for surrendering appropriate trading losses.
Large companies (ie companies that are not SMEs) may claim R&D tax relief for 130% of the qualifying expenditure (125% prior to 1 April 2008).
What is a SME?
- Broadly, a company is a SME if it (together with any company in which it holds 25% or more of the capital or voting rights) has:
- an annual balance sheet total not exceeding 86 million (43 million prior to 1 August 2008).
fewer than 500 employees (250 prior to 1 August 2008) and an annual turnover not exceeding 100 million (50 million prior to 1 August 2008) and/or
If a company changes from a large company to a SME owing to this increase in the limits, any period that straddles this date will have to be split into two separate periods for the purposes of calculating the relief due.
In addition, a company will not be a SME if 25% or more of its capital or voting rights are owned by enterprises that are not themselves SMEs (with limited exceptions).
A company will generally cease to be a SME in the second year that it exceeds those thresholds, providing an extra year to claim relief.
Are there other qualifying conditions for SMEs?
Budget 2008 announced two new qualifying conditions for expenditure to qualify under the SME regime. As the SME regime falls within the European Commission’s (EC’s) rules on State aid, these changes are being introduced to ensure that the SME regime continues to meet the requirements of the EC s State aid Framework.
The new qualifying conditions are that:
- the latest published accounts were prepared on a going concern basis, and nothing in those accounts indicates that they were only prepared on that basis because of an expectation that the company would receive R&D tax relief or R&D tax credits
- the R&D aid on the R&D project does not exceed 7.5 million.
If the 7.5 million cap is exceeded, the excess expenditure can qualify for relief under the large company regime. Both conditions are effective from 1 August 2008.
Is there a minimum expenditure level?
To claim R&D tax relief, a company must spend more than £10,000 on qualifying R&D in the accounting period. This amount is prorated for periods other than 12 months.
What expenditure qualifies for relief?
R&D tax relief is given on revenue expenditure incurred during the relevant period on:
- qualifying staff costs & for example salaries and bonuses, Class 1 national insurance contributions (and other European Compulsory social security contributions) and pension payments relating to staff directly engaged in R&D including technical support, planning and organisation of the research. However, qualifying staff costs do not include benefits in kind.
- computer software directly used in undertaking the R&D consumable or transformable materials used in the R&D process. This includes water, fuel and power.
- externally provided workers–expenditure incurred by the company on workers who are not employees of the company carrying on the R&D, but instead are paid through an intermediary, such as an agency.
- payments made to clinical trial volunteers – this category of expenditure has qualified from 1 April 2006 for large companies and from 1 August 2008 for SMEs.
Expenditure met by another person (eg through a contribution or a grant) does not qualify for relief under the SME scheme. In addition, if any part of the project costs is met by ‘notified State aid’ (which includes some government grants) then none of the expenditure on that project qualifies for relief under the SME scheme. However, if the expenditure would have been allowable had the SME been a large company, and the expenditure does not qualify under the SME scheme only because it was subsidised, relief can be claimed under the large company scheme instead.
What about sub–contracted R&D
SMEs – where part of the R&D is subcontracted to another person, R&D tax relief will still be available to a SME, provided the company retains ownership of the rights to any R&D knowledge produced. In these circumstances, the qualifying expenditure is 65% of the total payment made to the subcontractor. The subcontractor will not be able to claim R&D tax relief. Different rules apply if the company and subcontractor are connected and it is also possible to elect for this treatment when the company and subcontractor are unconnected.
SMEs are able to claim the 130% relief for work that is subcontracted to them by a large company or a body not subject to UK tax.
Large companies – can claim the relief on work they sub–contract out, provided that they sub–contract to a ‘qualifying body’ (broadly, non profit–making organisations). Large companies carrying on sub–contracted R&D can claim the relief provided that the person who sub–contracted the work to them is a large company or would not be chargeable to tax on the profits of its trade eg a foreign SME, charity or a Government Agency.
How is R&D tax relief utilised?
Tax relief is available in the accounting period in which the expenditure is incurred rather than when it is written off to the profit and loss account.
R&D tax relief simply increases the deduction from taxable profits, thereby reducing the profit or creating an allowable trading loss. A loss incurred by a SME can be used to claim a R&D tax credit.
What are R&D tax credits?
Payable R&D tax credits assist SME companies who have not made a profit and would not benefit immediately from R&D tax relief. A claim can be made if the company has made a loss in the trade in which R&D is carried out, by surrendering the loss attributable to the R&D in exchange for a cash payment.
R&D losses may be surrendered for cash up to the lower of:
- the amount of R&D tax relief claimed during the accounting period, and
- the total loss of the trade for the period after R&D tax relief, reduced by all claims and reliefs that have been, or could be, made to use the loss.
The amount of the tax credit payment is the lower of 14% (16% prior to 1 August 2008) of the R&D loss surrendered, and the total gross PAYE and Class 1 NIC paid for all employees (not just R&D staff) in the accounting period. Class 1A and 1B NICs are excluded from this calculation as are other deductions. Although the amount of the payable credit reduced from 16% to 14% on 1 August 2008, the overall value has actually increased from 24% to 24.5% of the qualifying expenditure.
How is the payable R&D tax credit or R&D relief claimed?
The company must claim the payable R&D tax credit and the R&D reliefs in its corporation tax self–assessment (CTSA) return for the accounting period for which the claim is being made. A claim can be made, amended, or withdrawn at any time before the first anniversary of the CTSA filing date for the accounting period.
How are claims checked?
HMRC has seven specialist units for all R&D credit and enhanced relief claims. The units deal with all R&D claims from companies apart from those listed below:
- companies dealt with by the Large Business Service
- companies dealt with by specialist pharmaceutical units in Manchester, Cambridge and Croydon
- companies dealt with by Small Company Enterprise Centres in Maidstone and Cardiff
- companies dealt with by HMRC Charities in Bootle.
HMRC can enquire into claims for R&D tax relief and R&D tax credit under the normal CTSA rules (ie within 12 months of the filing date or deadline). However, the specialist units will aim to process claims for payable credits within 28 days or raise an enquiry within 30 days.
If an enquiry is opened, all or part of the tax credit payment can be withheld. If a claim proves excessive, any additional tax due or excess R&D tax credit paid can be recovered and interest charged. There are also anti–avoidance rules to counter attempts to manufacture or inflate the amount of relief due. In these cases the amount of relief or credit will be disregarded.
As R&D claims are made under CTSA, they will be subject to the new penalty regime. This regime came into force in respect of return periods commencing on or after 1 April 2008 for returns filed after 31 March 2009. Therefore, it is possible that decisions being undertaken now could affect future returns and it is essential that ‘reasonable care’ (the new defining term) is taken when completing returns. The maximum penalty can be as much as 100% of the underpaid tax.
Who should I contact?
If you need further information on the above topics please contact your accountant, Independent Financial Advisor or Find an IFA.