A simplified introduction to the R&D Tax scheme
The R&D Tax Scheme is brilliant but like most tax schemes its choice of language can be a somewhat confusing.
If you’re interested in tax savings, and indeed cash payments from HMRC, but you don’t know your Expenditure Enhancement from your Enhanced Expenditure then this post is for you.
Objective of the R&D Tax Scheme
The R&D Tax scheme is designed to ‘encourage scientific and technological innovation within the United Kingdom’.
The scheme works by reducing the corporation tax chargeable to companies that are spending money on the type of R&D that HMRC recognizes as contributing to innovation in the UK. This extends to providing tax credits (cash payments) under certain circumstances.
Two different R&D Tax Schemes
The overall R&D Tax scheme actually comprises of two separate schemes:
The large company scheme
The SME scheme
Unless a company employs more than 500 staff and has a turnover or balance sheet total in the high tens of millions of pounds it will qualify for the SME scheme.
The remainder of this post addresses the SME scheme only.
(It should be noted that SME’s are also permitted to claim under the large company scheme and that one of the most common reasons to do so is when they are the recipient of a grant that prohibits their use of the SME scheme.)
What counts as R&D?
In general, and to paraphrase the HMRC guidance, a company will be involved in R&D for the purpose of the tax scheme if it is:
Working on a project that is seeking an advance in a field of science or technology where solutions are not common knowledge and where there is an uncertainty that a competent professional could not readily resolve.
You can read more about what counts as R&D in the HMRC simple guide here.
What counts as Qualifying R&D Expenditure?
For the purpose of the scheme, Qualifying R&D Expenditure is defined as the sum of all costs that qualify as R&D expenditure including, but not limited to:
The full salaries of employed staff directly and actively engaged in the R&D project along with a time-based apportionment of the salaries of those who supervise them.
A proportion of the costs of any externally provided staff or subcontractors contributing to the R&D project.
Any software or consumables involved in the R&D project
The Qualifying R&D Expenditure is the cornerstone of the R&D Tax Scheme and the basis for all tax relief and tax credit calculations.
You can read more about how to calculate the Qualifying R&D Expenditure here.
How to calculate R&D Tax Relief
Having determined the Qualifying R&D Expenditure outlined above, the steps to calculate the R&D Tax Relief are straightforward:
Take 130% of the Qualifying R&D Expenditure and call this the R&D Expenditure Enhancement.
Reduce the company’s Net Profit by this R&D Expenditure Enhancement amount for the purpose of calculating the corporation tax it owes.
And that’s it.
By doing this, the company making the R&D claim has effectively been given tax relief to the value of the corporation tax due on the Expenditure Enhancement.
Here’s an example of the difference that can make:
Payable Tax Credits
If following the steps above results in a loss for the purpose of calculating corporation tax then an additional Tax Credit option is available to the company:
The company can ‘surrender’ the resulting loss to HMRC in exchange for a cash payment equal to 14.5% of this loss.
The maximum value of the loss that can be surrendered is capped at the sum of the Qualifying R&D Expenditure and the R&D Expenditure Enhancement. This value is called the R&D Enhanced Expenditure.
Why the term ‘surrender’? Essentially it’s because this loss is already valuable to the company even if it does not claim the R&D Tax Credit. In this way, the company is very much giving-up or handing-over (e.g. surrendering) the loss in exchange for the tax credit.
If the company does not surrender the loss then it can be used in future years to offset taxable profits and thereby potentially make tax savings at the prevailing rate of corporation tax (e.g. 19%) which would likely exceed 14.5%. If the loss is surrendered for the tax credit, then the company no longer has this option.
Whether or not a company should surrender the loss for the tax credit depends on a number of factors including its cash flow and profitability forecasts.
The only comment to make in general is that for many businesses, definitely getting the 14.5% in cash right now is often preferable to waiting in the hope of a greater saving sometime in the future.
We hope you have found this post to be informative and that it helps a few more UK businesses to take advantage of a scheme that has been well designed for the purpose of propelling innovative businesses forward more quickly.
Disclaimer: Every effort has been made to ensure the accuracy of this post but we do not warrant its accuracy. Always read and understand HMRC’s guidance on tax matters relevant to the business or person in question before taking or refraining from any action.