Research and development tax credits – how to claim and save

Posted on: 19 March 2015

What are R&D Tax Credits?

David Bennett is a tax partner at Moore and Smalley, the accounting, business advisory and tax planning services provider. David has over 25 years’ experience in providing specialist tax advice, and the topic many of his clients are speaking to him about at the moment is Research & Development (R&D) tax credits.

Here David explains all you need to know about R&D tax credits, including what qualifies, what doesn’t, how much you could save and how to avoid your claim being rejected.

Last year, HMRC gave £1.4 billion in tax relief on research and development, spread across 15,000 companies. But far from being a ‘loophole’ that they want to close, HMRC are keen to widen the net and increase the number of companies who claim R&D tax credits – especially small businesses.

Now is therefore a great time for small to medium sized businesses to have a look at the R&D they do and consider whether they too can get a tax refund.

The R&D Scheme

So how does the scheme work? Large companies often have a dedicated R&D department, and teams of people just working on R&D. SMEs are more likely to include R&D within the roles of multi-tasked individuals.

So the question to ask is “where have we invested time in developing new products and processes?”. And then, crucially, “how much of that work entailed us breaking new ground in the field of technology?”.

Qualifying R&D

Tax relief is given on “qualifying R&D” which is largely about overcoming technological uncertainty, using original thinking rather than following methods that are already well known and publicised.

But R&D does not have to be successful in order to qualify. If fact, failed R&D projects are a good way of demonstrating to HMRC that the company really is trying to break new ground.

Qualifying Costs

Tax relief is given on very specific categories of cost, which are:

  • Staffing: salaries, bonuses, NIC and pensions for people involved in R&D. Typically, a percentage of the cost will be taken, by reference to the proportion of time spent on R&D. HMRC does not insist on time records, and will accept an estimate where a reasonable approach is taken at arriving at it.
  • Software bought especially for R&D.
  • Materials, used in prototypes for example.
  • Consumables, such as materials used up in R&D, water, heat, and fuel. Rent, rates and hire costs are not included.
  • 65% of subcontractor costs.

How Much Is it Worth?

R&D tax credit is given in two ways, depending on whether the small business is profitable or has tax losses.

  • Profitable companies obtain enhanced tax relief on their R&D expenditure, resulting in a saving of £250 per £1,000 of expenditure. This is on top of the normal tax relief of £200 per £1,000 of expenditure, resulting in a total of £450 relief. This will increase to £460 from 1 April 2015.
  • A company with a tax loss can “cash in” the loss, resulting in a repayment of £326 per £1,000 of expenditure. A tax loss can be created even where the accounts show a profit, through capital allowances, for example, or as a result of the R&D tax relief claim itself.

Exclusions

No R&D tax relief can be claimed at all on a project if any state aid has been received for the project. Before claiming grants that are state aided, a calculation should be carried out as to which has the greater benefit – the grant or the R&D tax claim.

Subsidies that do not fall into the “state aid” category will result in a lower level of R&D tax relief.

Time Limits

There is a strict time limit to R&D research and development tax credit claims. A claim must be made within two years of the accounting period end.

A company with a 31 March year end therefore has until 31 March 2015 to make a claim for 2013. HMRC will not accept late claims.

How to Go about It

When claiming an R&D tax credit, a report should be prepared describing the R&D activities carried out and the problems that you were looking to overcome. It is always tempting to focus on the end product, pointing out that such a product has never been made before. To do so is to put the focus in the wrong place. HMRC will point out that new products can, and often are, developed without overcoming technological uncertainty, and it is that phrase, “technological uncertainty” that is the key.

By way of example, a company I worked with recently were manufacturing signs from plastics, which were then painted. As a result of environmental regulations, the paint supplier had to change the ingredients of the paint, and it lost some of its adhesive quality. As the paint could not be changed, the sign manufacturer had to develop new formulations of its plastic. The result was, in the customer’s eyes, the same as the old sign, but it required R&D to get there.

Similar examples can be found in manufacturing where new processes are developed to produce the end product more cheaply or efficiently, as long as technological uncertainty is involved.

And although manufacturing accounts for the largest proportion of claims, there is sometimes R&D in software design, particularly where new algorithms are developed.

New Developments

HMRC is looking at ways for making it easier for SMEs to claim back R&D tax credits, and will soon be launching a system to enable companies to discuss their claim with HMRC in advance. It is good to see HMRC encouraging SMEs to make claims, but I wonder whether they will look beyond what is put in front of them.

A good tax adviser will talk to you about everything you have done, and then formulate a claim. The advantage of this approach is that it will help you to make sure you do not miss out on any areas you had not thought of, as well as making sure the claim does not cover things that will get knocked back.

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