Essential Guide to R&D Tax Credits

R&D Tax credits
R&D Tax credits

The UK prides itself on having the most successful R&D tax credits frameworks in the globe.

Introduced in the year 2000, the R&D tax credit is a government-backed scheme that rewards innovation and advancement in technology.

As per this scheme, companies can file for the R&D tax claim for the costs of R&D activities carried out in that accounting period.

Is your business connected with innovations?

If so, your business can also be eligible to claim R&D tax credits.

And you know! This scheme is not just limited to the technology sector. Let’s find out if your business is eligible to take advantage.

This Blog Post Is Divided Into Following Sections

What Are R&D Tax Credits?

The Research & Development tax credit is the scheme of the UK government that provides businesses either corporation tax deduction or cash credit to compensate for the cost of up to 33% of research and development.          

The business of every sector can use this scheme as long as they are related to activities such as developing new products, services or modifying old ones.

According to HMRC, there have been 59,265 R&D tax credit claims for the tax year 2018-19 amounting to over £5 billion.

How R&D tax credit works?

R&D tax relief basically provides financial assistance to both profitable and loss-making companies via the corporation tax calculation.

By using this scheme, profitable companies can reduce their tax liability, for historic years this results in a repayment of overpaid tax.                                         

While for loss-making companies R&D claim will increase as the loss arising and can be set against the company’s future or past profits.

On the other hand, the loss attribute to the company’s R&D activity can be surrendered to the UK government in turn for a cash payment.

Also, you can use this skim every year once you have made the initial claim.  

The benefit you gain from the R&D tax credit is totally dependent on the corporation tax, the cost of R&D activities and whether you are SME or large cape company.     

Visit our guide about Corporation Tax to find out what UK corporation tax means, how to calculate, how to submit and when you have to pay.

The Key Benefits of R&D Tax Credit

The R&D tax credit is valuable for the businesses which are connected with research and development of innovative products of services with the many other benefits such as,      

No restrictions

As mentioned before, there are no particular restrictions for any industry to apply, but every business is welcome to use the R&D tax credit.

Not repayable

You do not need to repay to the HMRC as these tax credits are the injection of cash to your business in order to boost the economic growth.

Fuelling the innovation

The R&D tax credit can save a huge amount of your R&D costs by which you can put your business at the forefront of national and international innovation.

Claim R&D tax for various costs

According to HMRC, you can claim a number of costs related to R&D activities including,

  • R&D staff costs
  • Software used directly in R&D
  • Prototypes
  • Clinical trial volunteers
  • Consumable items – water, electricity, fuel etc.
  • Contributions to independent research

Who is eligible for R&D tax relief?

First thing first, to claim the R&D tax credit, a company must be subjected to UK corporation tax.

This means that the company must be registered in the UK as a public limited company or a private limited company.

In addition, if the branch of any overseas company has its presence in the UK and subject to the corporation tax, then that company can also benefit from the scheme.

Activities that might be eligible for R&D tax credit are as below,

  • Development of Software – e.g. development of new Virtual reality game or device.
  • Development of ICT hardware – e.g. new firewall hardware
  • New construction techniques – e.g. innovative and eco-friendly materials
  • Engineering design – e.g. development of new packaging with a unique chemical structure
  • Innovation in Bio Energy – e.g. product that uses biomass as a fuel
  • Agri-food – e.g. growth of hybrid crops which can tolerate climate change
  • Cleantech – e.g. development of innovative and energy-efficient products
  • Life and health science – e.g. production and research on COVID-19 vaccine.

Eligibility checklist

To know whether you are qualified for the R&D tax credit, ask the following questions to yourself and if you get the answer “yes” then it is worth exploring your business is eligible or not.

  • Is your company working on the development of the innovative product or significantly improved product, service or process?
  • Is your company working on a project whose results are uncertain due to some technical constraint?
  • Is your company working on projects which include technical challenges that are outside of the company norms?
  • Is your company working on a project which had a totally challenging environment, conditions, or configurations?
  • Do you have a team including scientists, engineers, architects, developers or technicians working on an innovative project?
  • Have your company or business developed software or product in-house?

Need guidance for a self-assessment tax return? We have made a detailed guide for you about the self-assessment tax return. Don’t forget to check!

What are the types of R&D tax credit schemes?

1.SME R&D tax relief

To qualify, SMEs must have,

  • Less than 500 employees
  • Turnover under 100m Euro
  • Must be eligible for UK Corporation Tax
  • The company must invest in R&D activities such as software, staff, prototypes etc.

Profitable SME businesses that fall into these brackets can deduct an extra 130% of their qualifying R&D expenses from their taxable profit, in addition to the normal 100%.

This makes a total of 230% tax deduction.

 If the SME has made a loss, it can claim a tax credit worth up to 14.5% of the loss.

2.Large company tax relief

If the annual turnover of your company is more than £100 million or a balance sheet of over £86 million, then you can claim your R&D tax under the RDEC (large company expenditure credits) scheme.          

RDEC scheme allows large companies to claim back 13% of their R&D costs which often adds up to some serious money.

In fact, recent statistics of HMRC suggest that the average RDEC claim is worth nearly £300,000.

Also, in some cases, SMEs can also claim RDEC such as if an SME is subcontracted by another large company.

Hey wait, have you set up a Government gateway? If not go set up the Government Gateway account and if you feel stuck our guide “How to set up a government gateway account” will help.

How to calculate R&D tax credit?

For the calculation of R&D tax credit, first of all, work out your qualifying R&D expenditure.

Let’s identify eligible costs of R&D activities for XYZ Company.

Expenditure ExamplesR&D Project ProportionQualifying CostsTotal
R&D staff – £90,000100%£90,000 x 100%£90,000
Raw materials – £30,00060%£30,000 x 60%£18,000
Software and license – £30,00010%£30,000 x 10%£3,000
Service providers & Sub-contractors
£20,000
60%

£20,000 x 60%£12,000
Other Utilities – £10,00020%£10,000 x 20%£2,000
Qualifying R&D Expenditure£125,000

Here for £125,000 is the qualifying R&D expenditure of XYZ Company.

Now, let’s assume that XYZ Company is SME and making a profit of £300,000

Calculations GBP
Profit £300,000  
R&D Qualifying cost £125,000
Enhanced R&D Qualifying cost£125,000 * 130%£162,500
Revised Profit£300,000 – £162,500  £137,500
Corporation Tax£137,500 * 19%£26,125
Corporation Tax Saving£57,000 – £26,125£30,875

The £125,000 is already accounted for as the qualifying R&D expenditure by XYZ company, so the R&D costs need to be enhanced by multiplying it by 130%, making it £162,500.

In the next step, the XYZ Company will deduct the R&D uplift from the profit to revise the profit, bringing £137,500 revised profit.

The corporation tax at 19% on the profit of £300,000 is £57,000. When subtracting that amount from the original corporation tax before a claim, XYZ Company will make the total saving for the R&D tax credit would be £30,875.

In the case of XYZ company is making a loss of £300,000,

Calculations GBP
Loss £300,000  
Corporation tax before the claim £0
R&D Qualifying cost £125,000
Enhanced R&D Qualifying cost£125,000 * 130%£162,500
Revised Loss£300,000 + £162,500  £462,500
Surrendable losses to HMRC£125,000 * 230%£287,500
Tax credit received£287,500 * 14.5%£41,688

Again, the £125,000 spent already on the qualifying expenditure of R&D activities, and after multiplying it by 130%, the enhanced R&D cost comes to £162,500.

This makes a revised loss for the year of £462,500.

At this stage, the loss-making company XYZ has two choices. They can carry forward the extra loss on future profit for extra tax relief deduction.

Or the XYZ Company can surrender losses now for cash through a tax credit of 14.5% of the amount as we have seen above. 

Final thought

If you find yourself stuck in the process of claiming an R&D tax credit, then get advice from specialists and let them do all the work. Because any mistake in this process can end up with an HMRC inquiry or penalty, you do not want this – it sucks! Hopefully, with the right guidance, you can get it right every time.