How is R&D tax relief calculated?
This guide is to help those who might claim for research and development tax relief. It will talk about the rules and regulations of such a tax relief as well as some common mistakes made when claiming such a tax break.
Which businesses can claim R&D Tax relief?
Any UK company, filing a corporation tax return that is undertaking R&D activity or spending money on it. Both profitable and loss-making businesses can claim R&D Tax relief. This could include:
- A company registered in the UK as LTD or PLC
- A branch of an overseas company with a presence in the UK
- A partnership of limited companies
The R&D does not have to take place in the UK, but the UK-registered company must fund it. For example, if a UK company subcontracts some of their R&D activities to an overseas entity, this could also be qualifying expenditure through the scheme.
What costs can be included in an R&D Tax Relief Calculation?
- Staff Costs – Including salaries, bonuses, employer’s National Insurance and pension contributions, and reimbursed expenses.
- Subcontractors and Externally Provided Workers (‘EPWs’) – Including companies that R&D work is subcontracted to and agency workers.
- Consumable Materials – Materials and consumables that are used up during the R&D process including heat, light, power and water.
- Software – Software licences needed to deliver the R&D project.
- Payments to the subjects of clinical trials.
You cannot claim for: the production and distribution of goods and services, capital expenditure, the cost of land, the cost of patents and trademarks, rent or rates, directors dividends.
How do I know if I’m an SME or a large company?
There are some differences in the rules about which costs are claimable between the two schemes for SMEs and non-SMEs:
- The SME scheme is available for businesses with 500 or fewer employees who have a turnover of less than €100 million or a balance sheet total of less than €86 million.
- Large corporations are able to qualify for the less lucrative Research and Development Expenditure Credit (RDEC).
There are other considerations to take into account that will have a bearing on what scheme you claim under, such as receiving grants and connected parties for example.
Connected or partner company
You are a connected company if:
- It holds over 50% of the voting rights in another company
- Another company holds over 50% of the voting rights in your company
- Partner companies
You have a partner company if:
- Another company holds over 25% of your voting rights or capital
- You hold over 25% of another company’s voting rights or capital
You need to include a proportion of the staff, turnover and balance sheets of partner companies. This should be based on the percentage of voting rights and capital that connects the 2 companies. For instance, if you own 30% of another company you should include 30% of its staff, turnover and balance sheets when calculating the overall size of the business.
What errors are commonly made when calculating R&D Tax Relief?
Payments to subcontractors
One of the most common errors we see when assessing claims is the calculation of subcontractors’ costs. Under the SME scheme you can only claim 65% of the qualifying spend.
If there is a £100,000 payment to a subcontractor, of which half is for R&D activities, the calculation would be £100,000 x 50% = £50,000 x 65% = £32,500. The £32,500 is therefore the qualifying amount added to other eligible costs.
Companies making losses
Another common error happens when calculating the benefit for a loss-making company. These can cash in losses to receive a “tax credit” payment from HMRC which is 14.5% of the loss. The total amount that can be claimed is 230% of the qualifying expenditure – which is the qualifying expenditure plus the 130% enhancement (also referred to as the uplift). However, losses can only be cashed in that were made in the same accounting year that the R&D claim is for. If the losses are carried forward from a previous tax year, then a tax credit payment is not available for them.
When should R&D Tax Relief be calculated?
R&D tax claims can be made up to 2 years after the end of the accounting period when the money was spent. However, we recommend making the claim as soon as possible after your accounting year because a claim could potentially reduce any corporation tax you need to pay, or your company could perhaps claim a tax credit and receive a payment from HMRC. The timing of the claim will also depend on the availability of statutory accounts and filing documentation.
How is R&D Tax relief calculated?
It can be confusing to calculate the benefit you could receive from claiming through the R&D Tax Credit SME Scheme.
Below are two calculations, both based on the company having a Qualifying Expenditure (QE) of £100,000 in the accounting year the claim is made for.
Example 1: Profit making company.
The 130% uplift is the extra tax deduction claimed through the scheme and is subtracted from the profit figure in the tax return. This gives a lower profit figure, on which the company will pay tax. In the example you can see how the R&D Claim reduced the Corporation Tax due by the company by £25,700.
|Before R&D||After R&D||Based on 100k Qualifying Expenditure|
|Tax adjusted profits||200,000||200,000||This is the profit figure taken from your accounts, adjusted for tax purposes.|
|R&D uplift||(130,000)||The R&D Tax Relief scheme allows a further deduction to be made, calculated as 130% of the qualifying expenditure identified - £100k QE in this example.|
|Adjusted profit/(loss)||200,000||70,000||This is how the R&D Uplift has reduced your profit figure.|
|Corporation Tax due||38,000||13,300||This is the effect of the R&D Tax Relief on your Corporation Tax liability.|
|Tax saving||25,700||The tax saved as a result of the R&D Claim.|
Example 2: Loss making company.
As the company is loss making, the 130% uplift increases its tax-deductible loss. The company can decide to carry the loss forward for tax savings against future profits OR HMRC will pay them a cash Tax Credit at 14.5% of the amount of loss being cashed in. Any remaining tax loss will be carried forward to the next accounting year.
|Before R&D||After R&D||Based on £100k Qualifying Expenditure|
|Tax adjusted profits||(200,000)||(200,000)||This is the loss figure taken from your accounts, adjusted for tax purposes.|
|R&D uplift||(130,000)||The R&D Tax Relief scheme allows a further deduction to be made, calculated as 130% of the qualifying expenditure identified. (£100k QE in this example).|
|Adjusted profit/(loss)||(200,000)||(330,000)||This is how the R&D Uplift has increased your loss figure.|
|Amount Cashed in for Tax Credit||(230,000)||£33,350 Cash payment due from HMRC
£100k QE + £130k Uplift = £230k Total x 14.5% = £33,350 Tax Credit
|Loss carried forward||(200,000)||(100,000)||Remaining balance carried forward to next accounting year.|
- There is a maximum of 230% of the original Qualifying Expenditure (QE) that can be cashed in.
- Only losses in the accounting year that the claim is made for can be cashed in. If they have been carried forward from previous years you will not be able to get a tax credit for them.
- From 1 April 2021, SMEs applying for R&D tax credits can receive a maximum of £20,000 in repayments per year plus three times the company’s total PAYE and NIC liability (subject to a couple of exemptions).
- There are other scenarios where the 130% uplift, can take a company from profit making into loss making., In these situations the same rules apply. The corporation tax due will be reduced and there will be an option to exchange the loss created for a cash Tax Credit.
Do you need further help calculating R&D Tax relief that you could be eligible for?
Every company’s situation is slightly different. We recommend checking your claim with an R&D tax specialist.