Research & Development (R&D) tax credits can either reduce a company’s tax bill, or in some cases provide a cash sum for those yet to make a taxable profit…
The Government first introduced the concept of tax credits for expenditure on R&D in April 2000. However, it would appear that many companies who could qualify are missing out on these valuable incentives; if this applies to you it’s never too late to appraise your circumstances. Here is a recap of the basic rules.
The tax reliefs available
Where a small or medium sized enterprise (“SME”) satisfies the qualifying conditions below, the company can make a claim to uplift its qualifying expenditure on R&D by 50% for tax purposes. This means that for every £100 of qualifying expenditure, the company can claim £150 as a deduction against its taxable income. The regime is being further enhanced by increasing the uplift on qualifying expenditure from 50% to 75%, although this change is subject to EU approval.
In addition, loss-making companies can also claim a repayment of tax equivalent to 24% of their qualifying expenditure. However, this is restricted to their total PAYE and NIC costs payable in the year. This can therefore result in a significant cash-flow benefit, particularly in the start-up phase or early years of the business.
The above reliefs apply only to expenditure which is revenue in nature. Capital costs (for example, those relating to the purchase of equipment used in the R&D process) may instead qualify for enhanced 100% capital allowances.
What exactly is meant by R&D?
Whereas the definition is somewhat complex, the R&D of the company must broadly entail an appreciable element of novelty that results in a scientific or technological advance or a clarification of an area of scientific or technological uncertainty. For example, in a software project, it may be necessary to demonstrate that software relies on newly developed algorithms or architectures which break new ground in the industry sector as a whole.
R&D can also include the design of products and services and software involving new technology or substantially improving existing products and services. This definition also includes the construction of prototypes. HM Revenue and Customs (HMRC) do not however consider piecemeal improvements of an existing product or service to be R&D.
When making a claim, the company must be able to demonstrate to HMRC that the product or service is truly innovative, cutting edge and, at a technological level, an advance on what is currently available in the market.
Conditions to be satisfied
The company must satisfy the following conditions:
It must be an SME and this is broadly defined as follows:
- Have less than 250 employees; and
- have an annual turnover not exceeding €50million (about £35million); and/or
- have an annual balance sheet not exceeding €43million (about £30million).
If the company is part of a group, the group must satisfy the above limits. The 2007 Budget proposed the doubling of all of these limits but this change is also subject to EU approval.
Other conditions are:
- The company must own the rights to any intellectual property (for example, trademarks or patents) generated as a result of the R&D;
- the company must have incurred the minimum qualifying expenditure of £10,000 in the accounting period for which the R&D claim is being made;
- relief is available only for qualifying expenditure (as defined below) incurred on R&D which is revenue in nature and which is not externally subsidised.
Any company that exceeds the size criteria for SMEs as described above is treated as ‘large’ but may still qualify for tax breaks, as set out below.
Qualifying expenditure
For these purposes, qualifying expenditure includes gross staff costs (although benefits in kind are generally excluded), 65% of sub-contracted R&D expenditure and the cost of items used up in the development process. It is also now possible to claim for the cost of software and power such as gas and electricity directly used in the R&D process.
What happens if you are a sub-contractor for R&D purposes on behalf of a large company?
Further reliefs were introduced by HMRC under the so-called large company regime for expenditure incurred on or after 1 April 2002. Where an SME carries out R&D on a sub-contract basis for a large company the enhanced rate of tax deduction is currently set at 130% with effect from 1 April 2008 (previously 125%)
Large companies themselves can also obtain an enhanced deduction at the same rate on their own qualifying expenditure. They are not able to generate a tax repayment on losses; however it is not a requirement that they own the intellectual property rights arising from the expenditure.
Key factors to enable you to maximise your claim
Many companies are failing to take full advantage of the tax breaks afforded by the above reliefs. In order to maximise your claim, the following key factors should be borne in mind:
- Identify the project
Only once a project has been identified can the associated costs be captured.
- Maintain supporting documentation
HMRC may require comfort that the project meets the criteria of a qualifying project for these purposes. Records should therefore be retained in support of the work done by the company in order to justify that the company has sought to achieve an advance in the field of science and technology.
- Capture staff costs
Timesheets should be prepared by staff in order to support the time spend and hence qualifying employee costs related to the R&D.
- Identify additional qualifying costs
Relief is also available for the cost of items used up in the development process, software and related utility costs. Invoices etc should be retained in support of this expenditure.
- Make sure you have the right structure in place
Relief can be restricted or completed denied if, for example, the related intellectual property rights are not held by the company or salary costs are borne by a different legal entity in the group. Seek advice up-front in order to avoid such difficulties.
How can Vantis help?
Vantis has now generated tax refunds and savings totaling over £1.5million for its clients investing in R&D. The projects have ranged from the fingerprint recognition systems to the development of robotic machinery for the flat-glass industry. We have also successfully assisted many clients who have undertaken ground-breaking work in the field of computer software.
Our R&D tax credit team at Vantis is headed up by Anthony Newgrosh. Anthony believes in working in close partnership with clients in order to identify all qualifying activities and related costs, preparing the submissions to be made to HMRC and dealing with any ensuing enquiries, often concluding with a face to face meeting with the Inspector of Taxes. The process is not onerous, only requiring the preparation of a brief synopsis of the R&D project, supported by a simple spreadsheet, detailing the corresponding costs. As always, there are many pitfalls in the legislation and, as set out above, there are time limits to the making of such claims. However, by addressing these issues at an early stage, Vantis have managed to obtain HMRC’s agreement to the vast majority of claims submitted without adjustment and in an extremely cost effective manner.
To learn more about how the relief may apply to your business or for assistance with making a claim please contact Anthony Newgrosh or enter your details and submit the online form below.