Even if you’ve only been in business for a little while, you’ve probably heard that research and development tax relief is available to businesses who are pushing boundaries in their chosen niche.
But what is it, and how do you know if you’re eligible to claim relief under the R&D scheme?
What is R&D tax relief?
The research and development (R&D) tax credit was introduced in 2000 to encourage small to medium-sized businesses to invest in innovation.
A separate scheme for larger companies was set up several years later; this is called the Research and Development Expenditure Credit, or RDEC.
Why did the government introduce R&D tax credits?
Back at the turn of the century, the UK government recognised that businesses needed to remain competitive if they were to continue to compete on a global scale.
They wanted to inspire limited companies to invest in new and improved products and services by allowing them to use their research and development activities to reduce their taxable profit and therefore keep their corporation tax bill to a minimum.
Because of the way the R&D tax relief system works, companies that make R&D a priority will benefit from a non-repayable cash injection that will make a real difference to their bottom line. More than this, however, any business that invests in innovation will not only be working to establish itself as a global leader in its field; it will also be contributing to faster economic growth on a national scale. In fact, every £1 spent on R&D in the public domain provides around £7 of net economic benefit to the UK.
How does the SME scheme work?
As we mentioned earlier, there are two separate R&D schemes: one for SMEs, and one for larger enterprises. Our clients fall into the SME category, so we’re going to talk you through how this particular scheme works – but if you’d like more information on the RDEC, please don’t hesitate to contact our accountants directly.
In a nutshell, the SME scheme provides smaller companies with a tax deduction of 230% on any money that they spend on qualifying R&D expenditure.
Here’s an example: if a small to medium-sized business spent a total of £100,000 throughout the year on expenses, but £10,000 of those costs were related to R&D, they would be eligible for a R&D claim of £23,000.
What kinds of businesses benefit the most from claiming R&D tax credits?
There are the obvious advantages of investing in new processes and technologies. Businesses that are continually innovating will improve their market position and their long-term viability.
But from a purely financial perspective, any company that wants to reduce its tax bill and pay less to HMRC will be able to use R&D tax relief to its advantage.
To illustrate this, let’s pretend Company A made a total of £200,000 in taxable profits in its last financial year. Right now, Company A would need to pay 19% corporation tax on this total, which amounts to £38,000.
However, let’s say the company’s R&D expense deduction worked out to be £46,000 because they spent a total of £20,000 on qualifying activities. So, £200,000 minus £46,000 equals £154,000 – and 19% of £177,000 is £29,260. That’s a saving of £8,740 in tax that could be redistributed elsewhere in the business for further growth.
And this is a relatively tame example. Say Company B’s taxable profits run into the millions, but they have identified that they spent a high percentage of their expenditure on qualifying R&D. Claiming R&D tax credits will chip a significant amount off Company B’s taxable profits and keep their corporation tax bill to a minimum – plus, they’ll be keeping their business ahead of the curve by investing in its future. It’s a win/win!
In addition, if they know how to utilise R&D tax credits in the right way, a business can adjust its books so it appears to be making a loss. In this case, the company would not need to pay corporation tax, and would be eligible to apply for a cash payment back from HMRC instead. This payment would be based on 14.5% of the qualifying R&D expenditure multiplied by 230%, or the total trading losses – whichever is lower.
How many UK businesses are claiming R&D tax credits?
More businesses than ever are taking advantage of the government’s R&D tax relief scheme.
HMRC’s own statistics show that 85,900 companies claimed R&D tax credits during the 2019-2020 period to a sum up £7.4 billion, a rise of 16% on the previous year. Data from 2020-2021 is due in autumn of this year, and we’re confident this upward trend is set to continue!
Could you be eligible for the SME scheme?
You may think you’re too small or too specialised to be able to claim R&D tax relief – but the truth is, these tax credits can be claimed by pretty much any business, in any industry.
To claim, you must have undertaken – or be undertaking – qualifying research and development activities. This includes creating new products, services or processes, or modifying an existing product or service. Typical projects involve creating enhanced versions of existing products; designing and coding apps to provide a quicker, better service to customers; and creating a solution to a specific industry challenge or to fill a gap in the market.
Your claim can cover most expenditure relating to your R&D project(s), including employee costs, subcontractor costs, software, materials and utilities. There are certain things you cannot claim for, such as producing or distributing goods, buying land, renting land or property, or purchasing patents or trademarks.
To qualify for the SME scheme, you will also need to have less than 500 staff, and a turnover of under €100m (c. £85m) or a balance sheet total of under €86m (c.£72m). If you are larger or generating more turnover than this, you will need to look into the RDEC.
How long does it take for R&D credits to come through?
For SMEs, HMRC aims to make R&D tax credit payments within 28 days of a successful application. Bear in mind, however, that it can take a further 10 days for the monies to clear in your business bank account.
Corporation tax refunds can take as little as a week, but timelines will depend on the complexity of your claim and whether it needs to be processed at peak times for HMRC.
Can you apply for R&D tax credits yourself?
As you can see, the criteria you need to meet are quite broad, and the list of ‘do’s’ and ‘don’ts’ is extensive.
It is certainly possible to complete and send a claim to HMRC yourself – but to streamline the process and make sure you don’t waste any time pursuing unqualified claims, we would always recommend speaking to an R&D tax relief consultant first.
The team here at AO Accountants can put you in touch with a tax specialist who can advise on the suitability of your claim(s) and even help put together an R&D technical report if they feel it will help to clarify your position and strengthen your case.
Remember, you can make a claim up to two years from the end of each accounting period.
Check out our recent blog for more ways to reduce your creative company’s tax liability in 2022/23, or contact our friendly chartered certified accountants for more tax-busting advice!