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This is part 1 of our 4 part guide for accountants that want to develop their knowledge, grow their practice and provide their clients with R&D tax relief services. Companies can also use this to prepare and submit their own R&D tax credit claims.
The other parts will cover:
Based on a proportion of Gross Domestic Product, the UK has historically not invested in research and development (R&D) as much as other countries. The Government noted that this proportion actually fell between 1981 and 1999, whilst in other countries it was increasing.
In 2000, the Government therefore introduced R&D tax relief to encourage UK companies to invest building a knowledge based economy and improve productivity.
The Government introduced two schemes, one targeted at small medium sized enterprises (SMEs) and the other for large companies.
The SME scheme is one of the most generous tax corporation tax reliefs available. This is a huge driver in companies claiming R&D tax credits.
The purpose of claiming R&D tax relief is to reduce a company’s tax bill, which improves their cash flow. Companies can claim up to 33.35% of their research or development costs.
Any money saved through R&D tax relief does not have to be paid back and unlike some other UK tax reliefs, there are no clawbacks or withdrawals. The company can spend the tax saving as it wants.
This enables companies to improve competitiveness by reinvesting into their company. It allows companies to fund innovation, efficiency, business growth or marketing.
Let’s say a company develops new software and claims R&D tax relief. The money saved (or refunded) can be reinvested in marketing the product or expanding the team to cope with increased consumer demands.
R&D tax credits can be claimed for projects that have been unsuccessful. For example, a engineering company is attempting to create a drone that can carry a load of 50 kg for three hours. The drone will be better than its competitors as it will be smaller in size, have a better battery life and a longer range. Let’s say the project fails, as the company is unable to create a smaller drone. The costs incurred to the point of failure can still be claimed.
Pre-revenue and loss making companies can claim a cash payment by surrendering their losses. See SME loss example below.
R&D tax relief must be claimed within two years of the end of the accounting period in which the development occurred.
For example, a company has a year end of 31 March and it undertook development of software between 1 July 2015 to 15 August 2016, it has development across two accounting periods. The R&D tax credit claim for the year ended 31 March 2016 must be claimed by 31 March 2018 and the claim for the accounting period ended 31 March 2017 must be claimed by 31 March 2019.
As mentioned, there are two variants of R&D tax relief.
To qualify for the SME scheme, a company has to have less than 500 employees with either:
If a company fails this, it is a large company.
There are other circumstances that will treat an SME under large company rules and these points will be covered in a subsequent article.
The qualifying conditions of the company and projects are the same, irrespective of the company size.
There are some differences in the costs that can be claimed and the process of completing the CT600 and the tax computation. These will covered in part 3 and part 4 of this series.
The schemes work differently, generally SMEs receive a tax benefit of 24.7% of their R&D expenditure. This means a company spending £100,000 on R&D can claim a tax saving of £24,700.
The scheme for large companies is known as research and development expenditure credit (RDEC). RDEC has a tax benefit of 9.72%. If a large company spends £1,000,000 on R&D, it can save £97,200 in corporation tax.
The SME scheme is therefore more generous in terms of tax savings.
R&D tax relief operates through the UK corporation tax system. There are different processes to claim R&D tax relief under the SME scheme and the RDEC scheme, but both involve the corporation tax computation and CT600.
Under the SME scheme, the qualifying R&D costs are uplifted by the relevant rate (currently 130%) to produce the enhanced expenditure. This enhanced expenditure is then included in the tax computation as an expense, in addition to the normal expense of 100%. This would either reduce profits or increase losses.
SME profit example
A company has a profit of £200,000 for the year ended 31 March 2017. There are qualifying R&D costs of £50,000. This amount is increased by 130% to £65,000 and included as an expense, resulting in taxable profit of £135,000. This is taxed at 19%, resulting in tax due of £25,650.
If an R&D tax claim had not been made, the company would have paid corporation tax of £38,000.
The claim resulted in a tax saving of £12,350 from only £50,000 of costs. The effective saving is 24.7% (£12,350/£50,000).
SME loss example
If an SME makes a loss in the year, it can still claim R&D tax credits. Going back to our previous example, let’s say the company made a loss of £100,000 prior to claiming R&D tax credits. After including the enhanced expenditure, the total loss is £165,000 (£100,000 + £65,000).
The SME has a few choices to utilise the loss:
The company can surrender losses up to the lower of:
Therefore the loss surrendered is £115,000.
The Payable tax credit is therefore: £115,000 x 14.5% = £16,675
By surrendering the loss of £115,000 the company will receive £16,675 in cash from HMRC. The remaining £50,000 (£165,000 – £50,000) of losses can be utilised using the other four options as mentioned above.
By surrendering the loss now, the company benefits from a cashflow advantage immediately.
Under the RDEC scheme, the net benefit of a claim is 9.72%. It is best to illustrate this through an example.
Let’s say a company has profits of £5,000,000 and has spent £1,000,000 on qualifying R&D. An above the line credit of 12% is added onto the income in the tax computation, so £120,000 is added. This increases the company’s profit to £5,120,000.
The company is taxed at the corporation tax rate of 19%, resulting in tax of £972,800.
A tax credit equal to the above the line credit (£120,000) is then included in the computation, reducing the tax payable to £852,800.
Without an R&D claim, the corporation tax would have been £950,000. The company therefore saves £97,200. The net tax benefit is calculated as £97,200/£1,000,000 = 9.72%.
To qualify for R&D tax credits, the business, the projects and the costs must all meet certain conditions.
As R&D tax credits operate through the UK corporation tax system, only UK companies are eligible to claim it. The company must also be a going concern at the time of the claim.
We shall cover qualifying projects and qualifying costs in subsequent articles.
In the past, the larger organisations were responsible for innovation but as technology and knowledge has become more readily available, innovation can exist in a one man company in the back of the garage.
It is up to us accountants to advise our clients that they could receive financial help through R&D tax credits. A single claim can help your clients save cash that can be reinvested into hiring new staff, get an upgrade in premises, buy new machinery or train staff on new production techniques. The money can help in many ways to guide our clients to achieve their business goals and personal targets.
Accountants are not expected to understand every aspect of tax law but they should be aware of them. R&D tax credits are a massive incentive to fund innovation and productivity.
The first step to make an R&D claim is to establish whether your clients are undertaking R&D activities. We shall cover this in Part 2 – identifying qualifying projects.
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