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R&D Tax Relief – Schemes & Case Studies

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R+D word cloudCompanies that have not yet considered how their products or services may fall within the definition of Research & Development (R&D) for tax purposes are likely to be missing out on significant tax savings through R&D tax relief.

R&D tax relief rewards companies that are seeking advancement in the state of knowledge in their sector. In the definition for tax purposes1, R&D does not necessarily mean the development of a new product. R&D can involve development of new or improved products, processes, services, devices or materials. Importantly, R&D is not limited to a particular industry. For example, R&D claims can be made in industries such as retail (e.g. improved processes), IT and telecommunications (e.g. software development), food and beverage (e.g. innovative recipes), engineering (e.g. new materials), manufacturing (e.g. automation) as well as the more well-known R&D industries such as pharmaceutical, biotechnology and energy.

There are two R&D schemes through which a claim can be made: SME (small and medium-sized enterprises) and RDEC (research and development expenditure credit). To claim through the SME scheme, the company must have a staff headcount of less than 500, and either a turnover of less than 100m, or a balance sheet total of less than86m. On the other hand to claim through the RDEC scheme, the company must have a staff head count of more than 500, a turnover of more than 100m, and a balance sheet total of more than86m. If a company fits the SME category as defined above but carries out subcontracted R&D or is in receipt of Notified State Aid, it would have to claim under RDEC.

Under the SME scheme, the company receives an additional 130% relief for qualifying costs, reducing tax liability (see Case Study 1 below). Alternatively, in the case of losses, an increased company loss can be surrendered for 14.5% cashback (see Case Study 2 below).

Under the RDEC scheme, the company receives a 12% credit based on qualifying costs that it deducts from tax liability. This results in an after-tax saving, based on 19% Corporation Tax rate, of 9.72%. In the case of losses, the company would receive a cash payment from HMRC.

Accordingly it is more beneficial to claim, where possible, under the SME scheme; however in order to qualify, the company would need to meet the above requirements to be classed as an SME for R&D tax credit purposes.

Qualifying R&D expenditure can include, for example, staff costs such as gross pay, employer NIC, employer pension and reimbursed expenses. It can also include costs for externally provided workers and subcontractors, although the costs for subcontractors are restricted if using the RDEC scheme. Costs for materials, software, heating, lighting and water are all examples of qualifying R&D expenditure.

Case Study 1: Brewing Industry (SME company)

R&D: development of unique beer formulations & analysis of existing brewing process to improve flavour

  • Taxable profit before R&D tax relief = £150,000
  • Estimated corporation tax liability before R&D tax relief = 19% x £150,000 = £28,500
  • Qualifying R&D expenditure = £100,000 (£50,000 staff salary; £50,000 consumables)
  • Enhanced R&D expenditure = £100,000 x 130% = £130,000
  • Adjusted taxable profit = £150,000-£130,000 = £20,000
  • Estimated remaining corporation tax liability = 19% x £20,000 = £3,800
  • Tax saving = £28,500-£3,800 = £24,700

Case Study 2: Technology Industry (SME company)

R&D: continued development of proprietary software platform

  • Taxable profit before R&D tax relief = £0
  • Company loss = £10,000
  • Estimated corporation tax liability before R&D tax relief = £0
  • Qualifying R&D expenditure = £100,000 (£100,000 staff salary)
  • Enhanced R&D expenditure = £100,000 x 130% = £130,000
  • Company loss including enhanced R&D expenditure = £140,000
  • Options:
    • Carry loss back if profits in period prior to R&D period
    • Carry loss forward
    • Group relief (if applicable)
    • Surrender loss for cash: £20,300 (14.5% of £140,000)

Companies could therefore benefit from significant reductions in corporation tax liability and, in the event of losses, even receive cashback. In both cases, R&D tax relief provides a mechanism to achieve additional savings which could be invested in new R&D or new IP.

Monica Patel 22 November 2018

1 R&D is defined for tax purposes in Section 837A of the Income and Corporation Taxes Act 1988, accounting standard SSAP 13 Accounting for research and development and the BIS guidelines (Paragraphs 3, 6, 9 and 13) which define the basis and eligibility conditions for claiming the relief. The actual legislation for R&D tax relief is found in The Corporation Tax Act 2009.

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