The R&D tax scheme aims to encourage investment in technological R&D by means of incentives delivered through the tax system. These incentives take the form of tax credits or tax relief against eligible R&D investment. The scheme was introduced in 2000 for small-to-medium enterprises (SMEs), with that for large companies following in 2002.
Almost £1 billion in support is claimed annually by UK businesses, but this still represents a substantial shortfall against the extent of R&D being carried out in industry - many companies have still not claimed their entitlement, most commonly because they are unaware that they even qualify or because they believe that the claim process is onerous.
The scheme works by allowing the SME to deduct an additional 130% (125% before 1 April 2015) of its qualifying R&D costs from its taxable income. A company with taxable profits will therefore benefit from a reduction in corporation tax payable, currently ranging from 25% to 26% of the qualifying R&D investment, depending on the company’s tax rate.
If the company has made a loss, then the scheme goes even further and allows the alternative of a cash payment of up to 33.35% of the eligible R&D investment (32.625% before 1 April 2015, 24.75% before 1 April 2014) in exchange for surrendering the potential tax loss associated with a proportion of the enhanced R&D expenditure that would otherwise be carried forward.
This option is, of course, very attractive to most startup companies, who may take some years to reach profitability and so prefer to realise the tax benefit of the R&D tax credits early in the life of the business. The scheme is therefore often regarded by early-stage companies as a valuable source of funding rather than just a tax incentive.
To qualify for the generous SME scheme, companies must meet a modified version of the EC definition of SME, the basic criteria being fewer than 500 employees and either a turnover below €100m or under €86m in total assets. Note that related companies are taken into account, which can often make the assessment complex, although there are certain exemptions for holdings by venture capital funds or universities.
Large Company Scheme
The scheme for large companies has also been improved recently. Prior to 1 April 2013, a large company (that is, one which exceeds the EC SME criteria) was able to deduct an additional 30% of its qualifying R&D spend. Unlike SMEs, large companies making losses did not have the option of surrendering tax losses in exchange for a cash payment. The R&D tax relief therefore only provided an immediate financial benefit if there were taxable profits available in the company or group against which to set it. From 1 April 2013 however a new system was introduced called the R&D Expenditure Credit (RDEC), featuring a payable credit, currently 8.8%, in most cases offset against corporation tax but potentially available as a cash payment too.
Qualifying R&D Costs
The R&D expenditure included in a claim for tax relief will fall into certain specified categories such as staff costs and consumables, so that general overheads (for example rent and rates) do not qualify. There are also differences in the range of claimable costs between SMEs and large companies.
Claims now can only be made within two years of the company’s year end. Previously a six year limit existed for claiming the superdeduction, meaning that companies must review their R&D activity more frequently to make sure they do not miss out on their entitlement.
It is important to carefully tie in the costs to the R&D project. For tax purposes, R&D is defined in guidelines published by the DTI. The definition is deliberately technology-neutral, so that claims are possible from any field of science or technology including engineering and software, not just the more obvious areas such as life sciences or nanotechnology.
Whatever the area involved, understanding the boundaries between the eligible R&D parts of a project and the ineligible activities is crucial. This is where specialist help is needed most.
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