Companies that incur expenditure on research and development (R&D) may be able to claim enhanced UK corporation tax relief. Small or medium sized enterprises (SMEs) may be able to obtain an enhanced 230% deduction or, if loss making, a payable tax credit of 14.5% of the enhanced deduction.

Large companies may be entitled to an R&D expenditure credit (RDEC). This replaced the old regime for large companies from April 2016 and provides an ‘above the line’ credit which increases profit before tax and can be payable in cash for loss making companies.

There are detailed requirements for each of the schemes, so this guide only provides a brief overview.

Qualifying R&D

In relation to both the SME relief and RDEC, the R&D activities qualifying for relief are activities that fall to be treated as R&D in accordance with generally accepted accounting practice (GAAP), as modified by R&D guidelines issued by the Department for Business Innovation and Skills.

The guidelines state that R&D for tax purposes will take place within a project that seeks to achieve an advance in science or technology. The activities that directly contribute to seeking to achieve this advance in science or technology through the resolution of scientific or technological uncertainty are R&D, together with certain qualifying indirect activities related to the project. However, activities other than qualifying indirect activities that do not directly contribute to the resolution of the project’s scientific or technological uncertainty are not R&D.

The guidelines say that projects which seek to do the following will be R&D:

  • extend overall knowledge or capability in a field of science or technology; or
  • create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or
  • make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or
  • use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way. An example would be a product that has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner.

Even if the advance in science or technology sought by a project is not achieved or not fully realised, R&D still takes place.

The question of what scale of advance would constitute an appreciable improvement will differ between fields of science and technology and will depend on what a competent professional working in the field would regard as a genuine and non-trivial improvement.

R&D begins when work to resolve the scientific or technological uncertainty starts, and ends when that uncertainty is resolved or work to resolve it ceases. This means that work to identify the requirements for the process, material, device, product or service, where no scientific or technological questions are at issue, is not R&D.

R&D ends when knowledge is codified in a form usable by a competent professional working in the field, or when a prototype or pilot plant with all the functional characteristics of the final process, material, device, product or service is produced.

Tax credits for SMEs

There is a special regime for companies which are small or medium sized enterprises (SMEs). They can obtain an enhanced deduction, equivalent to 230% of the qualifying expenditure or, if they are loss making they can claim a payable tax credit of 14.5% of the enhanced deduction.
A company will be an SME for R&D tax credit purposes if it has, when considered together with linked and partner enterprises:

  • fewer than 500 employees;
  • either an annual turnover not exceeding €100m, and/or a period-end balance sheet total not exceeding €86m; and
  • less than 25% of its capital or voting rights owned by one or more companies that are not small or medium-sized.

As well as being an SME, the company must be a going concern and carry on a trade. It must own any intellectual property that might arise from the R&D project.

The expenditure must be revenue expenditure, deductible in computing the profits of the company’s trade in the period. Revenue expenditure which has been capitalised for accounting purposes may still qualify for the relief.

The expenditure must be in-house direct R&D or the qualifying element of a sub-contractor payment in respect of R&D contracted out by the SME. In-house R&D will constitute staffing costs, software or consumables, externally provided workers and payments to the subjects of a clinical trial.

For the SME credit to be available, the R&D project must not receive total relief of more than €7.5m. In addition the company must not have been contracted to carry out the R&D and the expenditure on R&D must not be subsidised. If these conditions are not satisfied, an SME may be able to claim RDEC. 

HM Revenue & Customs (HMRC) has an 'advance assurance' service for SMEs which have not claimed R&D tax credits before and have an annual turnover of £2 million or less and less than 50 employees. If HMRC is satisfied that the R&D to be undertaken will qualify for the relief this will be confirmed by the advance assurance and for the first 3 accounting periods of claiming R&D tax relief, HMRC will allow the claim without further enquiries.

R&D expenditure credit for large companies

RDEC was introduced in 2013, originally as an alternative to the previous R&D regime for large companies, but since 1 April 2016 is the only relief available to large companies. Large companies are companies which are not SMEs.

RDEC can also be claimed by SMEs that fail to meet certain of the criteria for SME relief, although the relief given is not as favourable as that under the SME regime.

A company is entitled to a RDEC at the rate of 11% of its qualifying R&D expenditure for an accounting period. It brings the RDEC into account as an additional receipt of the trade for the accounting period. The 12% rate applies to expenditure from 1 January 2018. The rate was 11% for expenditure from 1 April 2015.

The credit is used as follows:

  • It is first set against the corporation tax  liability of the company for the same accounting period
  • Any balance is then reduced to a net of tax amount. The notional tax amount is available to discharge future corporation tax liabilities
  • Any balance remaining is capped by the amount of PAYE and NICs paid by the company in respect of the R&D staff.  Any amount which exceeds the cap is carried forward and treated as an expenditure credit for the next accounting period
  • The amount remaining then discharges corporation tax liabilities of the company for any other period
  • If the company is a member of a group it may surrender any amount remaining for a corresponding accounting period
  • Any remaining payable credit element is then applied in discharging any other outstanding liability of the company to HMRC, such as VAT or PAYE
  • After all restrictions and set offs have been applied, the remaining amount is payable in cash.

An anti-avoidance provision prevents claims from being artificially inflated.

Patent box

Note also that the patent box regime enables UK companies to elect for a lower tax rate for profits earned from patented inventions and certain other intellectual property rights.

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