Everything you need to know about research and development tax credits

The UK’s tax system is complicated and many people find research and development (R&D) tax credits especially tricky to understand.

This is partly because what actually counts as R&D is judged on a case-by-case basis against criteria that can seem almost abstract. To qualify as R&D for tax purposes for example, your project must contribute to a wider understanding in a particular field. It can’t just be a superficial change to existing technology.

What’s more, making this judgement requires expert scrutiny. There’s simply no way to run it as an automated box-ticking exercise and the validity of your claim depends on what else is going on in your sector. Even a claim that’s perfectly valid in its own right can be cancelled out if another company turns out to have done essentially the same work, reaching a similar solution.

Below we explain everything you need to know about R&D tax credits, who can claim relief and what the RDEC scheme is.

A quick guide to R&D tax credits

Currently, R&D tax credits allow small companies to deduct an extra 130% of their qualifying costs from any profits. This is on top of the existing 100% of qualifying costs that can usually be deducted which means there’s a total potential deduction of 230%.

This relief was launched by the UK government in 2000 with the intention of boosting innovation. The idea was to encourage businesses already working in this territory and, more importantly, to incentivise those not already actively pursuing innovation.

Successive governments have held this ambition because it’s in everybody’s interest to position Britain as an economy built on technology, engineering and design rather than on manufacturing industries, services and retail.

They wanted to see more firms like the electrical appliance giant, Dyson and computer chip company, Arm. The introduction of R&D tax credits appeared to have the desired effect as data released by the Office for National Statistics (ONS) last year revealed that UK businesses spent an incredible £23.7 billion on research and development in 2017.

Your claim for R&D tax credits is made as part of your annual corporation tax return. It then takes around 30 working days to process that claim. There can sometimes be delays however if your business is large, if your claim is especially contentious or if HMRC has had a high volume of R&D tax credit claims that year.

Fortunately, there’s an option to run your first claim past the Revenue in draft form to get an initial indication of whether it’s a non-starter, potentially saving everyone a lot of time.

Who can claim R&D relief?

To claim R&D tax relief under the SME scheme, your company should have a turnover of no more than €100 million or less than €86m on the balance sheet. You also need to have fewer than 500 full-time staff.

You don’t have to be in the technology or engineering sector to be an innovator. As long as your company undertakes scientific or technological projects which focus on developing new products or processes, or substantially improve existing ones, you might be eligible for R&D tax breaks.

Research which leads to environmental benefits is likely to be looked upon favourably because this is a big topic governments are being forced to address at the moment.

To add to the confusion, it’s also possible to claim R&D credits for software development.

This can seem especially complicated to non-experts because there’s no physical product or ‘invention.’

The example HMRC gives for this is a game developer devising a new system for the interaction of 3D objects on screen which reduces the amount of code and processing power required to achieve the same output. That’s an underlying improvement – it’s not just about how the game looks or its gameplay mechanism.

In a separate example, back in 2004, Andre Geim and Kostya Novoselov of the University of Manchester succeeded in producing sheets of graphene – a substance only a single atom thick, 300 times stronger than steel, nearly transparent and amazingly good at conducting heat and electricity. The global market for graphene is expected to be worth £170m by 2025. In that context, it’s no wonder the development of advanced materials is an area for research focused on innovation.

Regardless of the sector you work in, there are some questions you can ask yourself that will give you a rough idea of whether your work may be eligible.

Does your research intend to achieve a technological advance?

To qualify for relief, it can’t just be about tinkering, cosmetic improvements or superficial innovations. A new shape for an existing product is unlikely to count, even if it is ‘commercially innovative.’ Furthermore, your work can’t be about advances in economics, social sciences, arts or humanities.

Does your work achieve an advance in overall scientific or technological knowledge?

Unless people outside of your business can learn from your work and build on it, then it probably won’t qualify for R&D tax relief.

Does the project address an uncertainty that a knowledgeable professional in your field couldn’t quickly and easily work out for themselves?

In plain terms, reaching a solution has to be hard work or need painstaking research. You should know what you want to achieve, but not whether it’s scientifically possible or feasible.

If you answered ‘yes’ to the above, your project may be viable and your business could get a well-earned financial boost.

There are various other technicalities to bear in mind however so the best thing to do is sit down with one of our experts who can talk through the qualifying criteria in full.

What’s the RDEC scheme?

If your business is too big to qualify for the SME scheme, or is ineligible because you’re a subcontractor undertaking work on behalf of another company, there is another R&D tax break you might be entitled to.

The research and development expenditure credit (RDEC) scheme came into effect in 2015 and offers a taxable credit at 12% of qualifying R&D expenditure for certain companies engaged in R&D.

There are seven steps to determine how the Revenue will deal with the RDEC. In summary, they will look to offset it to discharge any existing tax liabilities the company has and when such avenues have been exhausted, they will pay the balance remaining as a cash credit to the company.

It’s limited to PAYE and the national insurance liabilities of the staff included in the RDEC claim.