1. R&D tax relief is not just for traditional scientific, blue-skies research carried out by people in white coats
The relief is for research and development. Therefore it includes experimental development into a new process, material, device or product. A claim should be considered if development:
(a) requires research to identify how to overcome particular scientific or technological uncertainties and
(b) in achieving this, makes an advancement in science or technology.
Furthermore, research that is undertaken to turn something that has already been established as technically feasible into a cost effective, reliable and reproducible item may also qualify. The rules for defining what constitutes a qualifying R&D activity for these purposes are set out in the DTI Guidelines, issued on 5 March 2004, and can be found via the HM Revenue & Customs (HMRC) website (www.hmrc.gov.uk).
Importantly the benefits are not just available to companies working at the cutting edge of science and technology. It may be that other companies have attempted to resolve the uncertainties and failed, or perhaps they have succeeded but the details of how this was achieved are not in the public domain. In either case valid technological uncertainty may exist.
2. There are two options available to an SME
An SME can claim either an enhanced 50% deduction against taxable profits for qualifying R&D expenditure or a cash rebate of 24p for every £1 of trading tax losses, not otherwise relieved, that is surrendered to HMRC. This is restricted by the company’s settled Pay As You Earn (PAYE) and National Insurance Contribution (NIC) liabilities for payment periods ending in that accounting period.
The definition of an SME for these purposes changed in January 2005 as follows.
For accounting periods ending on or after 1 January 2005, the business must have:
- less than 250 employees and
- either a turnover not exceeding €50 million or balance sheet gross assets not exceeding €43 million.
For accounting periods ending before 1 January 2005, the business must have:
- less than 250 employees and
- either a turnover not exceeding €40 million or balance sheet gross assets not exceeding €27 million and
- conform to the criterion of independence i.e. not owned 25% or more either individually or jointly by enterprises not meeting the definition of an SME.
Large companies, i.e. those who do not meet the above criteria, can only claim the enhanced deduction at a lower rate of 25%.
3. There are a number of qualifying R&D costs that SMEs can claim
The main categories of qualifying R&D costs are; wages, consumable items – including materials, water, fuel and power, computer software, subcontracting costs (restricted to 65% if unconnected or cost if connected) and externally provided workers (same restrictions as subcontractors costs). The company must have a minimum of £10,000 of qualifying costs in an accounting period of 12 months.
Before identifying the qualifying costs a company must first consider the following restrictions:
- If a notified state aid has been received in respect of a project, the costs on that entire project do not qualify for the relief. A notified state aid is any government support which has been reported to the European Economic Committee (EEC). Typically this includes the DTI’s research project grant and development project grant as administered by Regional Development Agencies. However, the company could consider a claim under the Large Companies relief which does not have such restrictions.
- Intellectual property arising from a project must vest wholly or in part with the company. The intellectual property arising may not be patented but in general, where the company can display that it has a real and material interest in anything that arises from the research, the test is satisfied.
- Claims under the SME scheme are only available to companies who undertake R&D projects on their own account and which is relevant to the company’s trade. Again, in circumstances where R&D activities are subcontracted to the company, it could consider a claim under the Large Companies’ relief.
In addition to the revenue reliefs available under the R&D tax credit scheme, it is worth remembering that capital allowances at 100% for qualifying capital expenditure on R&D is available to all companies and includes providing facilities for carrying out R&D. This is something that is often overlooked and yet can provide a significant tax saving in years where investment in R&D equipment has been necessary.
Once the qualifying costs have been collated and the claim calculated, it is entered in the relevant boxes on the Corporation Tax Self Assessment Return Form (CT600).
5. Is it worth it?
Yes, if a company has a committed strategy for continued investment in R&D. Realistically there are few companies today that do not need to keep updating their products, processes or services to keep abreast of technology. Whilst the investment in the first year may in some cases seem disproportionate to the benefit, a sound methodology adopted in year one can provide benefits for many years to come.