Research and Development expenditure
There are several ways that HMRC allows business to claim for research and development (R&D) expenditure. Most small and medium size enterprises (SMEs) are able to claim under the SME tax relief scheme. Qualifying R&D expenditure under the SME tax relief scheme is entitled to an additional 130% deduction from your pre-tax profits. The effect of this is that the company receives 24.7% off this expenditure in its tax bill by submitting an R&D claim. Furthermore, with corporation tax expected to rise to 25% from 1 April 2023, this saving increases to 32.5%, giving a significant incentive to invest in innovative projects that will grow your business.
What is qualifying expenditure?
The definition of R&D is quite broad for tax relief purposes. It is not limited just to work in scientific laboratories and can include engineering and process improvements. The specific questions to ask are as follows:
1. Am I seeking an advance in a field of science or technology?
2. Does the advance extend the overall knowledge or capability in the field of science?
3. Does the project involve an uncertainty that competent professionals can’t readily resolve?
It’s not just enough to increase your own knowledge so if there are other people already doing what you are trying to develop, this does not count as a qualifying project.
The uncertainty question means you need to be looking into something where you don’t know if it’s even technically possible to achieve a desired outcome.
Overall, the focus in your claim should be directed towards the problem you are overcoming, rather than just a product you are developing which is a good idea.
Once these elements have been established, of the main expenses that will qualify for the relief are wages, national insurance and pensions, consumable materials, and utilities costs. Subcontractor costs such as consultants do qualify, although subcontractor claims are less generous with only 65% of costs being eligible for the claim.
Implications of Covid-19 support measures
If you have funded your R&D projects with government support, the SME tax relief scheme will not be available. The Coronavirus Business Interruption Loan Scheme (CBILS loans) do count as state aid and therefore R&D funded by this will not qualify.
The alternative in this situation is to claim the Research & Development Expenditure Credit (RDEC) which is the same scheme that large businesses use. This works by taking 13% of qualifying expenditure and adding this to profits before tax. This amount is then deducted in full from your tax bill. An example comparing the different reliefs is outlined below.
The impact of business structure
The benefits of R&D tax relief and patent box claims are only available to companies, not partnerships (including LLPs) or sole traders. Therefore, an innovative business that is not yet incorporated should consider doing so to reduce the tax due on their profits, as well as several other advantages of being a company. However, a company as a partner of a partnership or LLP may make an R&D claim according to their share of profits and costs.
Making an R&D relief claim is usually
complex, but the benefits of doing so can be substantial. Contact your manager
to discuss your eligibility and if your expenditure will qualify to maximise
the advantages of these opportunities in growing your business.