Research and Development Tax Relief and Expenditure Credit

Research and Development Tax Relief and Expenditure Credit

Understanding Research and Development (R&D) Tax Relief and Expenditure Credit UK

Research and Development (R&D) tax relief is a valuable government incentive designed to encourage innovation and growth within businesses. It provides tax relief on qualifying R&D activities, allowing companies to reinvest in new projects and further innovations. Whether you’re a startup or an established corporation, R&D tax relief can significantly reduce your tax liabilities and boost your bottom line. In this comprehensive blog, we’ll explore the basics of R&D tax relief and expenditure credit, the types of expenses that qualify, the precautions you should take when making claims, the importance of a solid report, and the latest changes to the schemes effective from April 2023 and April 2024.

1. What is Research and Development Tax Relief and Expenditure Credit?

R&D Tax Relief is a tax incentive offered by many governments to encourage businesses to invest in innovation and new technologies. It allows companies engaged in qualifying R&D activities to reduce their tax liabilities or claim cash credits. The relief is designed to reward companies for creating new or improving existing products, services, or processes.

In the UK, there are two main R&D tax relief schemes:

• Small or Medium-sized Enterprise (SME) Scheme: This scheme is for smaller businesses, defined as those with fewer than 500 staff and either a turnover of less than €100 million or a balance sheet total under €86 million. SMEs can claim up to 130%/86% extra on qualifying R&D costs, in addition to the 100% deduction they already get, giving them a 230%/186% deduction on R&D expenditure.
• Research and Development Expenditure Credit (RDEC): This scheme is available for large companies but can also be used by SMEs that do not qualify for the SME scheme (for example, those receiving state aid). The RDEC allows companies to claim a credit equal to 13%/ of their qualifying R&D expenditure (for financial years starting before April 2023).

The R&D Expenditure Credit scheme is particularly useful because, unlike the SME scheme, it appears above the line in the accounts, making it more visible to shareholders and investors. The credit can either reduce the company’s tax bill or, in some cases, result in a cash payment.

2. Expenses We Can Claim in Different R&D Schemes

One of the key benefits of R&D tax relief is the ability to claim various expenses incurred as part of your R&D projects. Here’s a breakdown of the types of expenses you can claim under the different schemes:

SME Scheme Eligible Expenses

1. Staff Costs: This includes the salaries, pensions, and National Insurance contributions of employees directly involved in the R&D project. You can also claim a proportion of wages for employees who spend part of their time on R&D.
2. Subcontractor Costs: SMEs can claim 65% of the costs of using a subcontractor for their R&D projects, provided they are not connected to the company. This can include consultants and freelance professionals involved in the project.
3. Software: Any software used in R&D activities can be claimed, especially if it is essential for designing, testing, or analyzing new products or services.
4. Materials and Consumables: These are items used or transformed during the R&D process, such as raw materials, water, fuel, and power. These costs can be claimed as long as they are directly related to the R&D project.
5. Prototypes: You can claim for the costs of developing prototypes that are created as part of the research process.
6. Research Contributions: Contributions to external organizations such as universities for research that your company is involved in can also be included.

RDEC Scheme Eligible Expenses

The RDEC scheme has similar rules to the SME scheme, but with some differences:

• Staff Costs: Salaries, pensions, and NI contributions of employees directly engaged in the R&D work are eligible.
• Expenditure on Materials: Consumables such as raw materials or components used in the R&D process can be claimed.
• Software: The cost of software required for R&D activities can be included in your claim.
• Subcontractor Costs: Unlike SMEs, large companies can only claim for subcontractor costs if they are working with certain entities, such as charities or universities.

3. Precautions to Take When Claiming R&D Relief

While R&D tax relief is a great opportunity to reduce costs, it’s essential to take several precautions to avoid errors or the risk of a HMRC inquiry:

1. Clearly Define Qualifying Activities

One of the most common mistakes companies make is failing to properly define their R&D activities. The definition of R&D for tax purposes is specific, focusing on projects that seek to make an advance in science or technology. Routine work, improvements that don’t involve technical uncertainties, and aesthetic changes won’t qualify.

2. Maintain Detailed Records

To make a successful claim, you’ll need to provide evidence that the R&D activities took place and that costs were incurred. Ensure you keep detailed records of all your R&D activities, including project reports, meeting minutes, and expenditure logs. Failing to maintain proper documentation could lead to your claim being rejected.

3. Segregate R&D Costs

Make sure to separate R&D costs from other operational expenses. This will not only simplify the claims process but will also help you avoid misallocation of costs. Track staff time spent on R&D versus non-R&D activities carefully.

4. Avoid Overclaiming

Overclaiming can result in penalties. Make sure that only the eligible portions of costs are included in the claim. For example, only claim the percentage of a staff member’s salary that relates to their R&D work, not their entire salary.

5. Watch for State Aid Issues

SMEs need to be cautious when receiving state aid, such as grants or other public funding, as this can affect eligibility for the SME scheme. Companies that receive state aid for a project may have to use the RDEC scheme instead, which is less generous than the SME scheme.

4. The Importance of a Good R&D Report/Project Submission

When submitting a claim for R&D tax relief, it’s critical to present a comprehensive and well-organized report of your R&D activities. Here are some reasons why having a detailed report or project submission is vital:

1. Demonstrating Eligibility

Your report should clearly outline how your project qualifies as R&D under the tax relief criteria. You need to demonstrate that your project sought to advance knowledge or technology in a way that involved significant technical uncertainty. The report should explain what the challenge was and why the outcome was not easily achievable.

2. Supporting Documentation

A solid report should include detailed documentation of costs and activities. This should tie specific expenses (like staff time, materials, and subcontractor costs) to the project and show that they were essential for the R&D work.

3. Strengthening the Claim

Providing a thorough, well-supported report will increase the likelihood that your claim will be accepted by HMRC without further inquiry. A poorly structured claim, or one lacking sufficient detail, can raise red flags and lead to delays, or worse, penalties if your claim is deemed invalid.

4. Avoiding Disputes

By providing clear, structured, and accurate information from the outset, you reduce the risk of a dispute with HMRC. This can help avoid time-consuming investigations or requests for additional information, which can delay the payment of your claim.

5. New Changes in R&D Relief Effective from 01-Apr-2023 and 01-Apr-2024

The R&D tax relief schemes have undergone significant changes in recent years, with further updates effective from April 2023 and April 2024. These changes are designed to tighten the rules and make the schemes more efficient.

Changes Effective from 1 April 2023

1. Rate Changes:
   • The additional deduction for SMEs was reduced from 130% to 86%.
   • The RDEC rate increased from 13% to 20%.

These changes impact how much relief companies can claim. SMEs will see a reduction in the relief available, while larger companies using the RDEC scheme will benefit from a higher credit rate.

2. New Focus on Cloud and Data Costs:
   • Cloud computing and data costs can now be claimed as part of R&D relief. This reflects the growing importance of these technologies in modern innovation and will be a welcome change for many businesses relying heavily on data analysis and cloud infrastructure.

Changes Effective from 1 April 2024

1. Restriction on Overseas R&D:
   • Starting in April 2024, there will be a significant restriction on the ability to claim R&D relief for activities undertaken overseas. This is a move by the UK government to encourage domestic innovation and limit the tax relief for activities conducted outside the UK.
2. More Stringent Reporting Requirements:
   • Companies will be required to provide more detailed information when making R&D claims, including a breakdown of the R&D activities and the costs associated with them. This is aimed at increasing transparency and reducing fraud in the system.
3. Advance Notification for First-Time Claimants:
   • Companies planning to make their first R&D claim will need to notify HMRC in advance. This measure is designed to reduce speculative or fraudulent claims by ensuring that companies have legitimate R&D projects in place before making a claim.

Conclusion

R&D tax relief and expenditure credit are valuable tools for businesses looking to innovate and grow. By understanding the schemes, carefully documenting eligible expenses, and submitting detailed project reports, companies can maximize the benefits of these incentives. However, it’s crucial to stay updated on the latest changes, particularly those coming into effect in 2023 and 2024.