In this article, we provide an detailed look at everything you need to know about the Research and Development Expenditure Credit - more commonly known as the "RDEC" for short.
What is the RDEC tax incentive and who benefits?
The Research and Development Expenditure Credit ('RDEC') is a UK Government tax incentive available to 'Large companies' (see definition below) and replaces the legacy enhanced corporation deduction (30%) with effect from 1 April 2016.
This supplements the SME R&D Tax Credit Relief and applies to companies that are not defined as SMEs.
It can also cover certain situations where the SME R&D tax relief is not available to SMEs (see further below).
RDEC: What are the key tax benefits?
The RDEC provides a reduction in corporation tax payable for profitable companies or a repayable tax credit for loss making companies that equates to 8.8% of the total qualifying R&D expenditure in the period
- The RDEC allows loss making Large Companies to claim cash tax credits from HMRC - previously only available to SME companies
- The RDEC allows profitable Large Companies to pay a reduced amount of corporation tax
- The RDEC provides a net cash tax benefit of 8.8% on qualifying R&D expenditure (at a corporation tax rate of 20%) - note that for expenditure incurred from 1 January 2018, the effective cash tax benefit will increase to 9.7%
- The RDEC allows for greater flexibility for Large Companies as they were previously ineligible for tax credit payments up until 1 April 2013
RDEC: Who is eligible?
SME - subsidised expenditure
Companies (or groups) that fail the SME thresholds for R&D tax purposes - see further below
SMEs acting in capacity of subcontractors on behalf of Large Companies
SMEs in receipt of grant funding or other subsidised R&D work
SMEs that exceed the maximum SME project expenditure limit of €7.5m
What is the definition of an SME for R&D tax purposes?
A SME is defined for R&D purposes as a company with:
- < 500 employees AND either:
- turnover < €100m OR
- gross assets < €86m
Group companies need to be considered plus linked or partner enterprises as part of this test.
RDEC Scheme: What costs are eligible?
The following costs are eligible under the Large Company RDEC scheme:
- staffing costs paid to directors / employees
- expenditure on externally provided workers
- software and materials
- contributions to independent research
- subcontracted - limited to qualifying bodies and individuals / partnerships
This is broadly similar to the definitions for SME R&D tax credits although particular note should be taken of the more restrictive interpretation of qualifying subcontracted costs.
RDEC: What is the credit rate?
The current rate of uplift on qualifying expenditure under the RDEC is 11% (10% up until 1 April 2015). The Autumn Statement 2017 announced an uplift in the RDEC rate to 12% for expenditure incurred from 1 January 2018.
The 11% uplift (12% from 1 January 2018) is applied to the total of the qualifying expenditure for R&D tax purposes under the Large Company scheme.
Up until 1 April 2016, Large Companies had access to two R&D tax reliefs:
1The legacy Large Company relief that provided for a 30% uplift in qualifying R&D tax costs OR
2The RDEC tax incentive
No R&D tax cash credit was available under the legacy scheme noted in point 1 above. This legacy Large Company enhanced R&D relief was phased out in full with effect from 1 April 2016
RDEC: How is tax relief given?
The RDEC operates differently to the SME R&D tax scheme in that the uplift on qualifying costs creates a taxable receipt in the profit & loss account - this compares with the SME scheme that recognises the benefit of the R&D tax relief solely through the company's corporation tax line in its statutory accounts.
The credit to the profit and loss account increases profits or decreases losses in the period.
This is why it is often referred to as an 'above the line' credit.
It is recognised above the line in order to reflect the benefit of the R&D tax relief to the company. As it can otherwise often be overlooked when processed solely through the tax line - treated in this way, it is more akin to a grant in how it is reflected in the company's accounts.
The credit is taxable and - assuming a corporation tax rate of 20% - the cash tax benefit is currently 8.8% of the qualifying R&D expenditure.
RDEC Calculation Example - Profitable Company
In this RDEC worked example calculation, we will apply the current 11% credit rate:
Profitable company example
Less: qualifying R&D tax costs
R&D Cash Tax Benefit = £35,200 or 8.8% of the £400,000 qualifying R&D spend
RDEC Example calculation - Loss-making Company
Loss-making company example
Less: qualifying R&D tax costs
CT @ 20% (on R&D tax credit)
R&D cash tax credit payable to company *
R&D Cash Tax Benefit = £35,200 or 8.8% of the £400,000 qualifying R&D spend *
* Note that there are other conditions that must be satisfied before a cash tax credit is payable to the company under the RDEC scheme (see further below).
As noted above, the rates and consequent cashflow impact will improve from 1 January 2018 when the RDEC rate increases to 12%. This partially offsets the decrease in corporation tax rate from 20% to 19% with effect from 1 April 2017.
Here is an example calculation of the RDEC under the new 12% rate.
RDEC: 7 steps to receiving your cash tax credit rebate
The 7 stage process is designed to ensure that only those companies that are up-to-date with their tax affairs and payments can benefit from the cash tax rebate option
We are going to simplify the 7 step test to 'just' 5 for our purposes. These five stages may be summarised as follows:
Deduction of corporation tax at main rate
The repayable tax credit is payable only after first deducting the corporation tax due (including on the tax credit) in the period
PAYE / NIC cap
The repayable tax credit is capped by the PAYE/NIC amount paid by the company in the period in relation to the staff engaged in the R&D - note that this cap does not take into account the % apportionment applied to the employee staff costs as part of the claim calculation
PAYE / NIC / VAT arrears payable first
The repayable tax credit is payable to the company only after HMRC has checked for any arrears in relation to corporation tax, PAYE / NIC or VAT that will be deductible against the credit in advance
Optional set off against group company CT liabilties
The repayable tax credit is offsetable against corporation tax liabilities of group companies in the period
Going concern requirement
The company must be a going concern to be entitled to the cash tax credit
Yes, you read it right - we've simplified the 7 stage test into 5 to capture the essence of HMRC's requirements.
RDEC v SME R&D Tax Credit Scheme: What are the differences?
Aside from the fundamental difference in application and approach to give effect to the tax relief within the financial statements of a company, the definitions that underpin the applicability of the R&D tax relief remain the same.
Administrative process for filing a RDEC claim:
With respect to process for filing a claim, a company is required to prepare and file a justification report that supports the underlying nature of the qualifying project work along with supporting claim calculations in the same way as under the SME R&D scheme.
Qualifying costs under RDEC:
In terms of the qualifying expenditure there is one key difference and this is in relation to subcontracted costs.
Subcontracted costs to companies are not eligible under the Large Company scheme. It should be noted, however, that 'externally provided workers' (EPWs) are an eligible cost and therefore it is more important than ever to get the distinction right between EPWs and subcontractor relationships when dealing with RDEC claims.
It should also be noted that in the more restricted situations where the subcontracted costs do apply (e.g. for work subcontracted to qualifying bodies such as Unis or to individuals), the 65% cap that applies under the SME relief does not apply.
RDEC tax incentive: Some practical issues to consider
The RDEC is applied in a fundamentally different ways to the SME R&D tax credit scheme and therefore there are number of issues to consider:
- How the tax credit is treated in the profit and loss account under accounting standards - sometimes it is classified as a grant; however, this is for discussion with your accountants or auditors
- Impact on the financial accounts going forward if an estimate is of the tax credit is included or the claim is later challenged by HMRC and subsequently reduced. It is important to track the credit subject to tax in the accounts and to make any adjustments in the tax computation for under or over charges to taxation
- Impact on quarterly instalment corporation tax payments should be considered for cashflow planning purposes given that the tax credit calculation has the effect of increasing taxable profits
- Impact on the effective tax rate for group tax planning given the higher profits subject to tax after taking into account the above the line tax credit
Don't forget about the Patent Box
The RDEC has been designed to work alongside the Patent Box and therefore companies with qualifying patents should ensure that they have considered how to optimise the Patent Box tax relief in addition to the RDEC.
How we can help you with your RDEC claim
We are specialists in R&D tax credit claims and can offer an end-to-end solution in preparing and filing your RDEC claim with HMRC.
We are also accountants so this means that we can also advise on how your claim fits into the 'bigger picture' of your overall company tax profile.
Give us a call for a no obligation discovery call: