R&D tax credits remain one of the best sources of funding for UK companies since their introduction back in 2000.

Average claim sizes have increased year on year as this generous tax relief has improved, combined with the fact that increasing numbers of businesses have become aware of it. Many companies now benefit from this tax incentive on an annual basis.

However, there remains confusion over who is eligible and what costs qualify for this UK government tax incentive - here we provide guidance to help entrepreneurs and Founders navigate this relief:

What R&D tax reliefs are available to claim?

There are two research and development tax reliefs in the UK:

  1. SME Scheme

  2. Large Company Scheme: Research and Development Expenditure Credit ('RDEC Scheme')

The SME R&D tax relief is the most generous of the two reliefs with qualifying companies eligible to recover up to 33% of their qualifying costs if loss making and up to 25% if profitable.

The Large Company RDEC relief is less generous with an effective rate of 11% on qualifying costs.

Who is eligible to claim?

Both R&D tax reliefs are administered by HMRC and the claims filed via a company's CT600 corporation tax return.

So to be eligible, you must be a UK limited company.

It doesn't matter whether a company is profitable or loss making as both can benefit from research development tax credits:

  • a loss making company can surrender the resulting enhanced R&D tax loss for a cash credit

  • a profitable company can reduce its corporation tax payable or claim a refund of corporation tax already paid

In summary, R&D claims can help all companies that carry out eligible activities from both an improved cash flow and balance sheet position.

It is also worth noting that companies can make retrospective claims. So claims can be filed for projects undertaken in accounting periods that ended in the past two years.

Who is ineligible to file an R&D claim?

Sole traders and partnerships (including LLPs) are ineligible to file a claim (unless an LLP is a member that holds an interest in a qualifying corporate company).

What R&D qualifies for tax purposes?

The definition of qualifying R D for tax purposes is set out in the BES Guidelines on the Meaning of Research and Development for Tax Purposes.

Firstly, a company must identify a qualifying project. This stage is important as the claimant company must define the boundaries of where the qualifying R&D work starts and ends - typically starting where a technological uncertainty was first identified and ending when it was resolved or overcome (or where the work is aborted due to insurmountable technical challenges).

All qualifying R&D claims must be in the areas of science or technology.

A qualifying project might encompass the development of a new product, new processes or services; or an improvement that goes beyond trivial or small changes to existing technology.

Remembering at all times that qualifying R&D for tax purposes must represent a technological advancement for the company's sector (rather than for the company itself).

Who decides what qualifies for R&D tax purposes?

HMRC applies the concept of a 'competent professional' to help determine what falls inside and outside the boundaries of R&D for tax purposes.

So the claimant company should consider whether the knowledge, capabilities and methodologies necessary to achieve the desired technical objective(s) could be readily deduced by a competent professional in that field.

Often, companies will employ highly qualified and skilled team members who are engaged in the R&D work and this should be specified in the R&D claim. It is also vitally important that these individuals are engaged in the process of preparing the R&D report and supporting claim calculations as HMRC will place significant onus on their evidence (or lack of) in support of a company's claim.

What does not qualify for R&D tax purposes?

The two gateways tests must be satisfied for any project to be eligible for R&D tax relief:

  1. Seeking a technical advance

  2. Have to overcome technological uncertainties

Seeking a technical or technological advance

The first test can often be failed by companies that are viewing the advance from the perspective of their own knowledge or capability rather than from the perspective of the wider sector. A company's competent professionals must be able to point to the baseline knowledge or capability in the sector and identify the 'gap' or advance necessary to achieve their specific technical objectives.

The absence of a product, process or service does not automatically mean that the work undertaken to fill that gap is qualifying R&D - rather it is a signpost that qualifying R&D activities might be undertaken if the work necessary goes beyond existing known knowledge or capabilities i.e. the baseline knowledge is extended and technical uncertainty exists.

This problem is common in the software sector where a software development company might (erroneously) consider project work to be qualifying R&D simply because there is no known 'Off-The-Shelf' software solution available to provide the necessary utility or functionality for a given purpose - this is insufficient in of itself, as the next step must be to specify where the technological advance and technological uncertainties lie.

Similarly, pure product development by a qualified and experienced professional might not qualify if the work carried out (albeit complex) follows a series of well-established steps or methodologies for a competent professional in that sector.

Have to overcome technological uncertainties

Although a project might result in an advance on what is already available in a sector, it is important for the company to be able to demonstrate that this advance involved technical work that went beyond commonly accepted or established methodologies or steps.

It is expected that competent professionals will often engage in work that is within their competence and will learn from new and emerging knowledge and capabilities in their field. Not all challenging or complex work will be qualifying R&D for tax purposes.

However, there might be occasions where, having established that there is a potential technical advance, there is uncertainty as to the theoretical or practical feasibility of the steps that the company thinks it will need to take - in other words:

You may know where you wish to get to, but you are unsure whether the steps you plan on taking will get you to your destination. It is likely, therefore, that you will have to engage in a systematic process of trial and error.

This is within the bounds of R&D.

Identifying eligible costs

The R&D tax legislation is prescriptive as to exactly what costs are eligible.

Qualifying costs for R&D tax relief purposes are as follows:

  • Staffing costs (i.e. gross salary, employer's NIC, pension contributions and certain T&S costs)

  • Subcontractors / Externally Provided Workers (note that subcontractor costs are not eligible under RDEC)

  • Software (licence fees)

  • Consumables (parts or materials used up in the R&D process inc power/utility/water costs

Note that costs such as rent, director dividends, hosting costs etc are not eligible costs.

As you can see, the rules for R&D tax credits can be quite complex and nuanced in places. This is where our experience of preparing and filing claims can be of benefit to you in helping you navigate and optimise your claim.