R&D Tax planning for the mid-market client

R&D Tax planning

The research and development industry is essential to a country’s economic growth. The UK government incentives SME businesses to invest in innovation by introducing R&D tax relief.

This blog post outlines the working of R&D tax relief for small and medium-sized businesses that will help you further in tax planning.

Overview of R&D relief

R&D is a CT (Corporation Tax) relief that will reduce the company’s tax bill if the company has tax profits or a refund if the company has tax losses. The level of tax relief depends on many factors, including the company’s size.

Under the plan, a small or medium-sized enterprise (SME) R&D tax relief benefits businesses by

  • Deducting an additional 130% of the qualifying costs from annual profit/loss, along with the primary 100% reduction, making it a total of 230% deductions,
  • Claiming a tax credit when the business makes a loss worth up to 14.5% of the surrenderable loss.

Projects that count as R&D

The project must attain the following to qualify for the R&D tax credits:

  • How is it working for advancement in science and technology?
  • Has the project overcome uncertainties?
  • How has it overcome the uncertainties?
  • How could the project not be easily worked out by an expert in the domain?

How to exhibit your project in R&D with the tax definition?

Are there any scientific or technological advancements?

The project’s aim must be on scientific and technological advances rather than describing the project, process, and functionalities. Even if your project is commercially innovative, it’s not enough to qualify under R&D projects.

Activities relating to arts, humanities, and social sciences are not generally counted as innovative science projects.

Did you encounter scientific or technological uncertainties?

A scientific or technological uncertainty will exist only when the knowledge of something is scientifically valid or technologically feasible, or someone can achieve it in real life. Additionally, it is not readily available or deducible by an expert in the same domain.

If you encounter a technical issue previously worked on in other projects, it won’t be a technological uncertainty.

How and when do you overcome the uncertainties?

You need to describe the methods used to overcome technological uncertainties. Also, include the investigation process and analysis taken to do so.

Additionally, explain the success and failure of the project and their impact on the overall project.

Why did competent experts not readily solve the uncertainty?

Several capable experts may have tried to solve these uncertainties but failed, or it was solved but not mentioned the process in the public domain. Under both these situations, a valid technological uncertainty can exist.

Types of R&D relief

R&D relief depends on business size and whether you are a project subcontractor or not.

Small and medium-sized enterprises (SME) R&D Relief

It is applicable for small and medium-sized businesses that are having

  • Not more than 500 staff
  • A turnover below 100 million euros or the total on the balance sheet is less than 86 million euros.

small and medium-sized businesses

Credit: Deloitte

Does your company have linked or partner companies?

Linked or connected companies

Linked companies should include the staff, turnover, and balance sheets in their total. The company is linked if

  • You have 50% voting rights in another company.
  • Another company has 50% voting rights in your company.

Partner companies

Partner companies must include a part of their staff, turnover, and balance sheets. Your company is a partner of another company if:

  • They hold more than 25% of voting rights or capital of your company,
  • You own more than 25% of the capital or voting rights of their company.

For example, if you hold 40% of another company, you must add 40% of their staff, turnover, and balance sheets to calculate if you are an SME.

Research and Development expenditure credit

A company with no corporation tax liability can receive a cash payment under the Research and Development Expenditure Credit Scheme.

Large companies working on R&D projects can claim RDEC, a tax credit of 11% of their eligible R&D expenditure until 31st December 2017. The tax credit increased to 12% from 1st January 2018 to 31st March 2020 and 13% from 1st April 2020.

What costs can you claim under the SME R&D relief?

You can claim certain expenses on an R&D project from when you start working on it until you discover a scientific innovation or the project stops due to specific issues.

The costs you can claim under R&D tax relief are

Employee costs

You can claim a part of salaries, wages, class 1 NICs, and pension fund contributions for the staff working directly on the project. Additionally, you can claim the cost of the administrative or support team that works directly to support your project. However, you cannot claim money for clerical or maintenance work.

If an external agency provides staff for your R&D project, you can claim 65% of their relevant payments. Make sure you discuss with an R&D tax expert before claiming the expenses under the tax relief.

Subcontractor costs

If you use a subcontractor for your R&D project, you can claim 65% of the costs.

Software

You can claim

  • Software license fees purchased for R&D project
  • A reasonable share of the cost for software used partly in your project.

Consumable items

You can claim the relevant portion of consumable items like materials and utilities used in the project.

Clinical trials volunteer

Several projects running in the pharmaceutical industry need clinical trial volunteers. You can claim the payments under the R&D tax relief.

What are the costs you cannot claim?

You cannot claim the cost for the following:

  • Production of goods and services and the distribution
  • Capital expenditure
  • Land cost
  • Patents and trademark cost
  • Rent or rates

How to claim R&D relief?

You can claim an R&D relief two years after completing your accounting period. You can enter your enhanced expenditure into the full Company Tax Return form CT600 to claim the relief.

How to calculate your enhanced expenditure?

To calculate your enhanced expenditure, you need to formulate the following:

  • Find out the cost directly made for R&D.
  • Subtract any subcontractor or external agency staff provider payments up to 65% of the original cost.
  • Add all the costs.
  • Multiply it with 130% to find the additional deduction.
  • Now, add that figure to the initial R&D expenditure to calculate the enhanced expenditure amount, which you need to enter into your tax return.

For example,

A business profit of a year is £500,000.
Before applying for R&D relief, the corporation tax @ 19% is £95,000.
R&D Expenditure in the business is £100,000.
SME R&D tax relief is 230%.

Let’s calculate,

AmountCalculation
£500,000Business profit before R&D
£130,000R&D enhanced deduction (£100,000 × 230%) £230,000 As £100,000 is already included in the profit figure, we can deduct only £230,000 – £100,000 = £130,000
£370,000Revised profit (£500,000 – £130,000 = £370,000)
£70,300Corporation tax @ 19% (£370,000 × 19%=£70,300)
£24,700Corporation tax saved (£95,000 – £70,300) = £24,700 approx 26%

If your business suffers a loss, you can surrender this and claim an R&D tax credit.

How to calculate tax credit for loss-making SMEs?

For example,

The business loss made in a year is £500,000.
R&D expenditure in the business is £100,000.
SME R&D tax relief is 230%.
Surrender credit is 14.5% of the enhanced R&D cost.

Let’s calculate,

AmountCalculation
£500,000Business loss for a year
£130,000R&D Enhanced Deduction (£100,000 × 230% = £230,000, but £100,000 is included in the loss figure so that we can add £130,000
£630,000Revised loss for the year (£500,000 + £130,000 = £630,000)
£230,000The maximum loss available to surrender to HMRC is £100,000 × 230% = £230,000
£33,350Maximum tax credit received (£230,000 × 14.5%) = £33,350

Upcoming changes

The Government is planning to make changes to the R&D Scheme. The measures include:

  • disqualify overseas costs
  • linking R&D tax credits to a multiple of PAYE/NIC liabilities
  • R&D must physically happen in the UK; few exceptions will exist
  • Allowing cloud and data costs

Wrapping up

R&D tax planning can be confusing and complicated. Therefore you can seek advice from experts working in this domain for years. They know about the changing tax laws of a country and can guide you throughout the tax preparation process.

However, before you claim R&D tax relief for mid-sized businesses, you must be sure about your SME standard and whether your company is investing in innovative projects. At the same time, your tax advisor will instruct you about other considerations for a healthy tax strategy.