Lindsey Wicks highlights the tax reliefs available for companies undertaking research and development.
The tax reliefs for research and development (R&D) are only available to companies within the charge to corporation tax; there is no equivalent income tax relief. Since the introduction of the reliefs in the year 2000, there have been numerous changes to the regimes with the aim of stimulating R&D expenditure and innovation.
In the 2014/15 fiscal year, government statistics show that a record breaking 20,935 companies made claims for some form of R&D tax relief, with 20,000 claims being made by small and medium-sized enterprises (SMEs) (Chart RD1, HMRC, September 2016). The value of claims in 2014/15 was £2.45 billion (Chart RD2, HMRC, September 2016). The biggest stimulus to claims by SMEs is attributed to the removal of the £10,000 minimum expenditure cap in April 2012.
The reliefs available
Enhanced rate of relief for SMEs
The current rate of enhanced R&D tax relief for SMEs is 130%. This gives rise to an additional tax subsidy (over and above the tax relief that is normally due on qualifying expenditure) of 24.7p for every £1 of qualifying R&D expenditure at the current corporation tax rate of 19%.
Payable tax credit
There is a possibility that even profitable companies could have tax losses owing to the enhanced rate of relief. Such companies can surrender their unrelieved losses attributable to R&D tax relief for a payable tax credit at a rate of 14.5% (which is less generous than gaining corporation tax relief by carrying forward the losses against future profits). The cap on the payable credit (which used to limit the credit to PAYE/NIC liabilities for a payment period) was removed for accounting periods ending on or after 1 April 2012.
Example: Payable credit or carry forward a loss?
Alpha Ltd (an SME) made a taxable profit in the year ended 31 March 2016 (before any claim for enhanced R&D tax relief) of £20,000. Alpha Ltd had incurred qualifying R&D expenditure of £50,000, which had been deducted in computing its taxable profit of £20,000. By claiming enhanced R&D tax relief at 130% on the £50,000, it can deduct a further £65,000, turning the £20,000 taxable profit into a loss of £45,000. As all of the loss is attributable to the enhanced R&D tax relief, Alpha Ltd could claim a payable credit of £6,525 (£45,000 x 14.5%). Alternatively, if Alpha Ltd anticipates sufficient taxable profits in the future, it could carry forward the loss to offset against those profits.
At a current corporation tax rate of 19%, it could get loss relief of up to £8,550 (£45,000 x 19%).
The research and development expenditure credit
Large companies are no longer able to claim an enhanced rate of relief. They must claim the research and development expenditure credit (RDEC) instead. RDEC is equal to 11% of qualifying expenditure and will generally be set against the company's corporation tax liabilities. However, in some circumstances, a direct payment will be made to the company.
Trap: SME R&D expenditure unable to qualify for enhanced relief
Not all SME R&D expenditure can qualify for enhanced relief. Examples where relief might not be due include:
- R&D subcontracted to the SME;
- subsidised R&D expenditure; and
- capped R&D expenditure.
Where SME relief is not available, it might be possible for the SME to claim RDEC instead.
R&D capital allowances
R&D capital allowances at 100% may be available on capital expenditure relating to the R&D activity.
What is an SME?
To be an SME for R&D purposes, the company must have:
- less than 500 employees;
- an annual turnover not exceeding €100 million or a balance sheet not exceeding €86 million.
This definition is based on Commission Recommendation (EC) No 2003/361, subject to a couple of additional qualifications. If the company has ‘partner’ or ‘linked’ enterprises (defined in the commission recommendation), the headcount, turnover, and balance sheet totals of those enterprises must also be considered. For linked enterprises, 100% of the linked enterprises’ figures must be aggregated. For partner enterprises, a proportionate amount of the figure must be aggregated.
Trap: Venture capital investment
HMRC might look closely at investment by venture capital companies to consider whether they may have control of the investee company.
What is R&D?
There are two tests for an activity to qualify as R&D for tax purposes:
- the activity must be treated as R&D in accordance with generally accepted accounting practice (GAAP); and
- it must be among the activities that fall to be described as R&D in the guideline issued by the Department of Trade and Industry in March 2004 (now the Department for Business, Innovation and Skills (BIS)).
The BIS guidelines give the following high-level definition of R&D, which is expanded upon in the body of the guidelines:
‘R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology.
The activities that directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D.
Certain qualifying indirect activities related to the project are also R&D. Activities other than qualifying indirect activities which do not directly contribute to the resolution of the project’s scientific or technological uncertainty are not R&D.’
The type of expenditure qualifying for relief has changed over time, so it is worth reviewing the list of what currently qualifies for relief. The current list of qualifying expenditure is:
- qualifying employment costs proportionate to the amount of time spent on direct R&D activities or qualifying indirect activities;
- externally provided workers;
- consumable or transformable materials used directly in carrying out R&D;
- payments to clinical trial volunteers;
- power, water, fuel used directly in carrying out R&D (but not telecommunications and data costs); and
- computer software used directly in the R&D.
A large company will generally not qualify for relief on expenditure for work subcontracted to another person unless that person is:
- a qualifying body (e.g. a charity, an institution of higher education, a scientific research organisation or a health service body);
- a partnership where the members are all individuals; or
- an individual.
Trap: SME subcontracting R&D to another person
Where R&D is subcontracted to an unconnected party, the company can claim R&D tax relief on 65% of the payment it makes to the subcontractor. Where the parties are connected, the company can claim R&D tax relief on the lower of the payment that it makes to the subcontractor and the relevant expenditure of the subcontractor, provided that the subcontractor accounts for the payment within a 12-month time limit. It is possible for a company and the subcontractor to jointly elect to be treated as if they are connected, even if they are not.
Claiming for the first time?
Companies can now gain advance assurance from HMRC that their claim will qualify where the company:
- has not claimed R&D tax relief before;
- has turnover not exceeding £2 million;
- has less than 50 employees;
- has not entered a disclosable tax avoidance scheme; and
- is not a corporate serious defaulter.
Making a successful claim for R&D tax relief will normally involve collaboration between those undertaking the R&D and finance professionals. Although there are no specific record keeping requirements for R&D tax relief, HMRC would expect project documentation and expense records to be available to substantiate a claim. Project documentation would normally fall within the realm of the R&D team. The finance team will also need the help of the R&D team to identify costs relating to the R&D and also to determine the allocation of employment costs to qualifying R&D projects (e.g. by the use of timesheets if employees are not engaged full-time on a single project).
HMRC has set out some guidance to its officers on what they should anticipate in its Corporate Intangibles Research and Development manual at CIRD80550, CIRD80560, and CIRD80570.
This article was first printed in Business Tax Insider in August 2017.