Research and development business activities in the UK are incentivised by two different tax benefit schemes; the Research and Development Expenditure Credit (RDEC) and Research and Development tax relief.
An estimated £84 billion of R&D tax relief goes unclaimed in the UK every year, largely because businesses are unaware of it, assume it doesn’t apply to them or simply don’t get round to making a claim. A good business accounting strategy should aim to make use of government tax credits and relief where possible.
So how do businesses know if they’re eligible for R&D tax relief, and how do they apply?
The Two Types of R&D Tax Relief
There are currently two types of R&D tax relief offered by the government.
Research and Development Expenditure Credit (RDEC) is aimed at larger enterprise-level businesses that fulfil the following criteria:
- Over 500 employees
- A turnover of €100m or more and at least €86m in gross assets
- The current rate of tax relief is 13% of qualifying R&D expenditure, which amounts to 11p for every £1 spent after Corporation Tax is deducted
Research and Development tax relief is aimed at small businesses and SMEs and is the more generous of the two schemes. It applies to businesses that meet the following criteria:
- Under 500 employees
- A turnover of €100m or less and under €86m in gross assets
- It allows companies to deduct an extra 130% of their qualifying R&D costs from their yearly profit in addition to the standard 100% deduction, making a 230% deduction
- If the company is loss-making, the credit is worth 14.5% of that loss
- The average R&D expenditure companies can recoup sits around 33.3% (considerably more than the 11p per £1 offered on the RDEC scheme
What Counts as Research and Development?
R&D expenditure has a rather specific definition that must be satisfied in order to claim tax relief on either scheme. R&D shares the same definition regardless of which of the two schemes a company applies for.
1) Has to be in the Fields of Science and Technology
R&D revolves around innovative material progress gained in the fields of science or technology, but does not cover theoretical fields such as maths, economics, etc. It does however apply to software development. R&D expenditure only applies to the research and development itself and does not apply to the subsequent manufacture and production of developed products.
R&D applies to every sector and industry, but some of the main industries that claim R&D credits are:
- IT; software development, AI, machine learning, cloud computing, augmented robotics
- Manufacturing; electrical and industrial goods, chemical production, process optimisation
- Food and drink; food and drink with low-calorie, fat, salt or sugar, etc, gluten and lactose-free, vegan foods
- Science and technology; engineering, architectural, biotech, security, admin and business support
- Wholesale, distribution and supply; process optimisation, energy-saving, lowering emissions, automation
- Clothing and packaged goods; developing natural or synthetic fibres, energy-saving, automation, material development
2) The Business Had to Overcome Uncertainty
R&D occurs when a business is uncertain about what approach to take and therefore needs to innovate a new approach that solves unforeseen or undocumented problems. An expert in the field will have to refer to all the evidence available surrounding the problem and decide that no pre-existing solution can suffice in fixing it and therefore, research and development has to take place.
A useful recent example is adapting foods to be gluten-free. Removing gluten changes the structure of food, which in some cases, has an undocumented effect on its integrity. Research to overcome that problem would qualify as R&D.
3) The Business Couldn’t Find Another Method to Overcome Uncertainty
As mentioned, the business must decide, via the advice of an expert, that there is no current option available for addressing the problem. The problem must satisfy the criteria of being unresolvable via avenues other than R&D. What Costs Count as R&D Expenditure? R&D costs apply solely to the R&D process itself, not any subsequent production of products. However, it does apply to prototype development.
The following costs qualify for R&D tax credits:
- Clinical trial volunteering costs
- Consumables used during R&D activity
- Developing prototypes
- Developing software
- Independent research costs
- Staff costs for those hired to work on R&D activities, including their salaries, employer national insurance contributions, and pension contributions
- The costs of subcontracting R&D work
Businesses can’t claim:
- Production costs
- Distribution costs
- Commercial rent or land costs
- The costs of patenting and trademarking
- Capital expenditures
How to Claim R&D Tax Credits
To claim R&D tax credits, businesses must write up a technical narrative that explains why the business is eligible for R&D tax credits. This must contain information explicitly relevant to:
- The problem
- Why there is uncertainty
- Why other solutions cannot be found and therefore R&D must take place
- How the tax relief will help
The purpose of the technical narrative is to highlight the economic benefits of the R&D activity. It must also contain precise and accurate details of R&D costs and expenditures broken down into a costing schedule. The more accurate and rigorous the technical narrative is, the better, but it’s best to stick to raw facts and figures rather than unnecessary prose and fluff.
The technical narrative should be attached to the business’s CT600 and the total R&D expenditure figure provided on the return. The claim will be reviewed by HMRC’s R&D tax specialist department and any calculated relief will be applied.
R&D tax relief is considerable for businesses with high expenditure on R&D activities and is very useful when those businesses turnover a loss or make only a small profit due to their R&D investment.
The technical narrative is usually prepared with the assistance of a tax accountant. Some small business accounting advice for SMEs claiming R&D tax relief is to be as specific as possible, and to understand what constitutes R&D.
Summary: What are R&D Tax Credits and How Do I Qualify?
R&D credits are designed to incentivise businesses that perform real value-adding R&D work within their industry. R&D applies to pretty much every industry and is not confined to physical processes or product development, it also applies to digital developments, process optimisation, refinement, automation and so on.
The scope for R&D is wide and thus, businesses shouldn’t assume they can’t qualify for the credit just because their processes and activities don’t appear as R&D on a superficial level.
Applying to R&D tax credits requires businesses to write up a technical narrative of what they’re doing and why it qualifies for R&D, as well as providing a cost schedule that breaks down qualifying expenditure.