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Research and Development

R&D tax credits are one of the most attractive reliefs available at the moment, given that they can often result in significant repayments in cash.

At the same time, it is intriguing to see how many businesses have ignored the reliefs that are available to them.

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, in plain language this means it can make a claim to uplift its qualifying expenditure on R&D by 75% for tax purposes. This means that for every £100 of qualifying expenditure, the company can claim £175 as a deduction against its taxable income. For expenditure incurred prior to 1 August 2008, the rate of uplift was 50%.

In addition, loss-making companies can also claim a Tax repayment of tax equivalent to 24.5% (was 24% prior to 1 August 2008) of their qualifying expenditure. However, this is restricted to their total PAYE and NIC costs payable in the year. There are therefore significant cash-flow benefits to be had, 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 R&D?

The technical definition of Research and Development is somewhat complex, but in broad terms it must involve 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, you may need 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 include not only the design of products and services and software involving new technology but also substantially improving existing products and services. The definition also includes the construction of prototypes. HMRC do not however consider piecemeal improvements of an existing product or service to qualify.

The most important thing is that you 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

You must be an SME which has:

less than 500 employees; and
an annual turnover not exceeding €100million; and/or
gross assets on the balance sheet total not exceeding €86million.

If the company is part of a group, the group must satisfy the above limits. Prior to 1 August 2008, these limits were halved.

Other conditions are that you:

Must own the rights to any intellectual property (for example, trademarks or patents) generated as a result of the R&D;
Must have incurred the minimum qualifying expenditure of £10,000 in the accounting period for which the R&D claim is being made; and
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 also a requirement that they own the intellectual property rights arising from the expenditure.

Summary

The R&D tax relief regimes provide significant incentives to companies undertaking ground-breaking research and development work. However, do take professional advice early on so as to ensure that the various qualifying conditions are met and suitable documentation is retained in support of a claim.

For more information on R&D please contact Will Smith

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