R&D Tax Credits Explained

The UK R&D tax credits incentive is one of the most generous tax reliefs currently available in the UK tax code and a vital source of funding for many companies from startups to fast growth companies and international groups.

Here we set out a detailed guide to help you navigate how this tax relief might help release cashflow into your business and potentially become an important source of funding year on year to help grow your business.

What are R&D Tax Credits?

The R&D tax relief can benefit both profitable and loss making companies and, in a nutshell, allows profitable companies to secure a reduction in corporation tax payable and for loss-making companies to claim a tax credit cash payment from HMRC.

The R&D tax credits relief is a UK Government tax incentive first introduced in 2000 for small and medium size companies.  A similar scheme was introduced for Large companies in 2002.

It is a Corporation Tax relief and is therefore administered by HM Revenue & Customs (HMRC) via the Corporate Tax Self Assessment system.

R&D Tax Credits: What is the definition of R&D?

The first important point to note about the UK R&D Tax Credits incentive is its breadth of scope.

It can apply to any company in any sector so long as your company is seeking to:

  • check
    develop a new product, process or service, or
  • check
    improve or modify a product, process or service that's already out there in the marketplace

How do you claim R&D Tax Credits?

R&D Tax Credits Relief is claimed via your company's annual corporation tax return.

A claim either reduces corporation tax payable for profitable companies or can result in a cash tax credit payment from HM Revenue & Customs for companies that are loss-making

  • Profitable tax paying company: benefits from a reduction in corporation tax paid / payable
  • Loss making company: benefits from enhanced tax losses or can surrender for an immediate cash tax credit receipt from HMRC
  • So in either in a profitable or loss-making scenario, the R&D tax relief can deliver positive cashflow savings

Profitable SME company

24.7% of R&D expenditure is recoverable since 1 April 2017

Example:

£100,000 qualifying R&D spend in the period

230% R&D tax relief (notional uplift for tax only)

£130,000 additional tax deduction against taxable profits

Results in £24,700 tax saving at 19% corporation tax rate

Loss-making SME company

33.35% R&D expenditure is recoverable since 1 April 2015

Example:

£100,000 qualifying R&D spend in the period

230% R&D tax relief (notional uplift for tax only)

£130,000 additional tax deduction against taxable profits

Results in £33,350 tax credit - 14.5% R&D tax credit rate

Who is eligible for R&D tax credits?

The good news is that this UK tax incentive is extremely broad in its application and can apply to companies across all different sectors (unfortunately the name "R&D" tax relief often results in many companies (wrongly) thinking it doesn't apply to them).

As the R&D tax relief is a corporation tax relief, it is only available to entities that are subject to corporation tax - such as limited companies. Unfortunately, sole traders and partnerships (without corporate members) do not qualify for this tax relief as they are subject to income tax rather than corporation tax.

The key message here is not to be put off by the title "research and development" and instead to focus on the technical project work that your company might have undertaken over the past couple of years and to what extent it sought to achieve an advance in your sector?    

Here are just some of the company sectors that we have successfully helped claim R&D tax credits:

Software sector

  • Software development
  • Software-as-a-Service (SaaS) platform dev
  • Cyber-security
  • CRM systems
  • Media platforms
  • Fintech platforms

Games sector

  • Games development
  • Back-end-as-a-Service (BaaS) systems
  • Game / edutech brain training
  • Virtual currencies

Ecommerce sector

  • Ecommerce backend
  • Logistics automation
  • Auction platforms
  • Payment platform integrations
  • Bluetooth tracking

Mobile sector

  • App development
  • Music apps
  • Media hosting platforms
  • UX improvements
  • E-reading platforms

Construction sector

  • Construction materials
  • Lighting design
  • Bathroom design
  • Business Information Systems
  • Room layout imaging

Health sector

  • Cell research
  • Medical devices
  • Hospital tracking software

Food & Drink sector

  • Recipe formulations
  • Water efficiency
  • Hotel booking system

Engineering sector

  • Advanced engineering
  • Oil & gas
  • Motor sports

Manufacturing sector

  • Music consoles
  • Beds
  • Lighting
  • Bathrooms
  • Footwear

Health & Safety sector

  • Health & safety software
  • Resource allocation
  • Hospital tracking software

Travel sector

  • Drone development
  • Travel doc security
  • Freight tracking

Your Company

  • ...................

This should give you an idea of the breadth of application of the R&D tax credits incentive...

The good news is that more and more companies are starting to realise the potentially significant year-on-year tax cashflow savings that the R&D tax relief can bring - but there is still much further to go...

Which R&D tax credit scheme might apply to your company?

There are two R&D tax relief schemes, depending on the size of your company:

1. Small or Medium Sized Enterprise (SME) R&D Tax Relief

2. Research and Development Expenditure Credit (RDEC)

The RDEC applies to companies that fall outside the definition of a SME (see further below) and can also apply in other cases e.g. where an SME receives subsidised or grant income to fund a R&D project.

We provide a detailed run through how the RDEC is applied to companies (including some worked RDEC examples) in this article.

The SME R&D tax relief is the more generous of the two government tax incentives.


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What is the SME definition for R&D tax credits?

To qualify under the SME R & D tax relief scheme the company (or group) must have no more than:

  • check
    500 employees AND EITHER
  • check
    turnover of less than €100m OR
  • check
    balance sheet total of less than €86m

Given the relative size of these specific R&D tax SME thresholds, the majority of UK companies will typically fall within the more generous SME R&D tax relief.

What is the R&D tax credits rate in 2017?

The SME scheme provides for an enhancement of 230% on qualifying expenditure from 1 April 2015 (up to 31 March 2015: 225%).

We have set out some worked examples below showing the how the claim calculations are applied in both profitable and loss making scenarios.

What is the effective tax saving under the SME R&D tax relief?

By applying the 230% super enhancement to qualifying expenditure, the effective tax rebate on qualifying expenditure incurred for a company may be summarised as follows depending on whether it is profitable or loss-making:

Profitable company - Post 1 April 2017

Profitable company - Post 1 April 2017

Loss-making company

24.7%

26%

33.35%

The differential in tax savings pre and post 1 April 2017 reflects the impact of the reduction in UK corporation tax rate from 20% down to 19%.

So expenditure incurred on qualifying expenditure is subsidised by the R&D tax relief to the tune of 24.7p in every £1 for profitable companies and 33.35p in every £1 for loss-making companies.

Example calculations are set out below:

SME R&D tax relief: Profitable company - Worked example

Profitable company example

Pre R&D claim (£)

Post R&D claim (£)

Turnover

1,200,000

1,200,000

Less: qualifying R&D tax costs

(400,000)

(400,000)

Other costs

(200,000)

(200,000)

Profit before tax

600,000

600,000

SME R&D tax relief (@ 130%) *

0

(520,000)

Revised taxable profits

600,000

80,000

Corporation tax payable (@ 19%)

114,000

15,200

Tax saving secured

98,800

Effective tax rebate on qualifying exp

24.7%

* Note that the uplift applied is 130% (rather than the full 230% noted above), as the "first" 100% (being £400,000) has already been deducted in reaching the original £600,000 profit before tax.

SME R&D tax credits example: Loss-making company 

Profitable company example

Pre R&D claim (£)

Post R&D claim (£)

Turnover

200,000

200,000

Less: qualifying R&D tax costs

(400,000)

(400,000)

Other costs

(200,000)

(200,000)

Profit before tax

(400,000)

(400,000)

SME R&D tax relief (@ 130%) *

0

(520,000)

Revised taxable profits

(400,000)

(920,000)

Corporation tax payable (@ 19%)

0

0

R&D Tax Credit @ 14.5%

133,400

Effective tax rebate on qualifying exp

33.35%

You can see from the above example, that a loss-making company can surrender the enhanced tax loss for a R&D tax credit at a current rate of 14.5% calculated based on either the enhanced R&D tax loss or total available period tax loss (whichever is smaller).

R&D Tax Planning for Loss-making SMEs

So in the above example, the total enhanced tax loss was £920,000 (£400,000 + £520,000 enhancement) and the total current period tax loss was also £920,000. This will not always be the case.

The R&D tax credit cash rebate can be restricted especially where a company is in a break-even or small profit position before applying the R&D enhancement.

We should also note that a company is not obligated to surrender the enhanced tax loss for a tax credit. It could elect to carry forward the tax loss to offset against its future trading profits and obtain relief at 19% (or possibly 17% in the future).

This would have a cashflow benefit versus surrendering the tax loss now for a tax credit of 14.5%. However, it is important to take into account the time value of money and the uncertainty over whether you will receive the cash benefit in the foreseeable future (if ever), especially if you continue to invest in R&D activities and receive the generous R&D tax break going forward.

Alternatively, if the company is part of a group, it could elect to surrender the enhanced tax loss to an eligible group company as "group relief" to offset against its taxable profits in the period.

What are the key requirements for a successful R&D tax credits claim?

  • You are undertaking a project that is seeking to develop a new or improvement to a product, process or service that, if successful, would result in an technological advancement on what's already available out there, and
  • You and / or your team are competent in your field but you're not entirely sure how you are going to achieve your objective from a technical perspective i.e. there is technical uncertainty, and
  • You have taken on financial and commercial risk by deploying your staff onto this technical project; perhaps taking on subcontractors to help solve it and / or investing in parts and materials (plus energy costs) used up in the project.

Here's a short video that should give you a flavour of the typical elements of a project that qualifies for R&D tax relief:

We often find that companies are quick to dismiss their eligibility for R&D Tax Credits based on an incorrect assessment by their accountant or simply themselves - given the amount that is at stake for companies, this could be a costly mistake!

Fortunately, a short discussion with experienced R&D tax specialists like ourselves (who have successfully filed and negotiated R&D Tax Credits submissions with HMRC for many years) ​typically helps identify projects that qualify for R&D tax credits relief

What R&D expenditure is eligible?

  • Staff Costs
  • Subcontractors
  • Externally Provided Workers
  • Software
  • Consumables
Staff costs comprises gross salary, employer's NIC and pension contributions (plus certain reimbursed expenses)

For each of the above categories of qualifying expenditure, it is necessary to consider what percentage of the total cost applied to the R&D project work. We can help you navigate these requirements

How far back in time can I make a claim?

There are strict time-limits but the good news is that you can make retrospective R&D tax claims for projects that fall within accounting periods ended in the past two years.

You can read more about how this time limit can work in practice in this post.

SME R&D tax relief - Common problem areas

Grant or subsidised project work

Dividends paid to owner-managers engaged in the R&D project work

Subcontractors - Documenting the contractual arrangement

We can help you navigate any tricky areas by applying our wealth of experience to get you on the right track.

R&D Tax Credit Claim Process - Claims made easy

Unfortunately there is no ready-made R&D tax credits template for SMEs as no one claim is the same.

However, you might be surprised by just how straight-forward the R&D tax claim process can be when we apply our simple tried-and-tested 5 step process:

​Step 1

A short discovery call to discuss your company's activities and to give you a "heads up" on the potential qualifying nature of your work

We won't waste your time if we don't think your activities qualify for this relief based on our extensive experience​

​Step 2

A meeting with you (and your technical team) to discuss all of the qualifying projects that the company undertook over the accounting periods ending in the past two years

From this meeting, we will collate the necessary technical and financial information to commence our detailed work on compiling the R&D tax claim

​Step 3

We will prepare the detailed technical report and supporting claim calculations in a format that HMRC prefer

We take care of all the prep work so that you can get on with running your business

​Step 4

We will agree on the final version of the report and claim calculations

We will share the claim figures with your accountants for inclusion in the (amended) company tax return(s). Or we can prepare amended returns for you

​Step 5

We will ensure that your R&D tax claim is filed with the relevant specialist HMRC R&D Unit and will track it through to agreement

HMRC normally process R&D tax claims within 4-6 weeks resulting in the cash being transferred to your bank account - only at this stage do you pay us our pre-agreed fee


Discover How the UK R&D Tax Credits Incentive Could Benefit Your Business

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Is it worth bothering claiming R&D Tax Credits?

Put simply there aren’t many Government-backed tax incentives that will actually put money in your bank account to support the technically challenging and valuable work that you are undertaking – let alone often within just 30-60 days of filing!

Average successful claims are £60,000+ and we have successfully secured several six figure cash tax saving claims within 5-6 weeks of engagement – consider in comparison:

  • how much equity you might need to give up to secure these levels of external investment?
  • stress of guarantees from the bank to receive this level of loan funding? or
  • products / services you would need to sell to secure this level of ‘profit’ direct to your bottom line?

Our clients have been absolutely thrilled with the results that we have secured for them and have used the R&D tax credits to invest in more staff, bigger premises and more technically advanced projects to keep them ahead of their competition

And remember, these are potentially year-on-year tax rebates if the R&D project work is ongoing!​

What could you use your R&D tax credits cash tax savings for?

HMRC: R&D Tax Credits Guidance