Guide to R&D tax incentives part one: What exactly is R&D tax relief?

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Research and Development (R&D), is an activity that up until a few years ago most people would think belongs in a lab, carried out by scientists in white coats.

No longer is that the case; more people are beginning to understand that R&D refers to the incremental and continual improvements made to all manner of products, services, technology and engineering. Unfortunately however, many businesses are still not aware of the tax benefits that they could be receiving for this sort of work.

The Government has made a big deal of supporting R&D over the last few years, having launched a series of funding programmes and commitments to increase total investment in this area to £31bn. A sizable proportion of this will be channelled into the private sector through a variety of fiscal incentives available for innovation such as R&D Tax Credits, Research and Development Expenditure Credits (RDEC), Research and Development Allowances (RDAs) and Patent Box.

In this, the first of a four-part series, we will take you through the following:

  • what exactly R&D tax relief is and how the individual schemes work;
  • what to consider when assessing the eligibility of projects, which are likely to qualify and what costs do not;
  • how to make a claim,
  • what records are required, and what happens when HMRC carry out an investigation;
  • as well as turning to Advance Assurance – a relief for small and medium enterprises (SMEs) – and whether your business should be taking advantage.

What is R&D tax relief?

R&D Tax Credits

The UK operates two R&D tax credit schemes, SME and RDEC (Research & Development Expenditure Credit) with a non-SME company defined as one that employs 500 or more employees and either turnover greater than £100m, or gross assets greater than £86m. This results in a rather generous definition of what constitutes an SME and, other than specific rules relating to linked or partner companies, most organisations will find themselves in the SME scheme.

The SME scheme is much more generous than RDEC, with cash benefit up to 33p per £1 of R&D spend, depending on the taxpaying position. This amount is reducing to 22p per £1 for expenditure incurred on or after 1 April 2023.

A key consideration

Many advisory firms will heavily promote the fact that companies that are not in profit can claim approximately 33p per £1 as a tax credit (a terrific cash boost for start-ups, for instance), however, the scheme is far more beneficial for profitable firms in cash terms.

Always consider the longer-term benefit of retaining tax credits if profitability is likely, as opposed to ‘burning’ through tax credits on the advice of firms looking to generate faster and/or higher fees.

Research & Development Expenditure Credit (RDEC)

RDEC, also known as ‘above the line’ credit, is available to firms meeting the above non-SME criteria and also SMEs for grant-funded or subsidised expenditure. Following the recent increase in the RDEC rate from 12% to 13%, this equates to a total tax saving of 11% of total qualifying expenditure, increasing to 20% for expenditure incurred on or after 1 April 2023 equating to a total tax saving of 15%.

Research & Development Allowances (RDAs)

Further to the two R&D schemes, there is also an opportunity to claim on the building(s) and equipment used for the purposes of qualifying research and development. This is often an area completely overlooked but will apply to those parts of the building not claimable under normal capital allowances rules and allows all expenditure to be written off in the year of expense. Therefore, if a new R&D facility is constructed for £5m then it may be possible to claim the entire expenditure as RDAs, which would essentially write off the entire £5m cost against the owner’s tax bill (approximately a £950,000 reduction in corporation tax).

Patent Box

Patent Box is a complementary UK government tax incentive designed to reward innovative companies. Introduced in 2013, it allows companies to pay the reduced rate of 10% corporation tax on profits derived from patents. To take full advantage, R&D must be performed in the UK and, as a further boost to profitable companies, can be claimed in addition to R&D tax credits.

The intention is to reward companies that protect their IP with patents or exclusively license UK patents and can apply to both patented products or processes. A patent need only protect a very small part of the whole for all the profits derived from the entire product to be eligible for the low tax rate.

The scheme recognises the length of time required to secure a patent and allows a company to apply the lower tax rate prior to the granting of a patent. Calculating the benefit of Patent Box can be complex involving the application of transfer pricing principles, so do take advice before embarking on a Patent Box election.

Click here for part two of the series, to learn about what activities and costs qualify for R&D tax relief, as well as what does not.