Nichola Ross Martin's Tax Consultancy

At a glance

R&D Relief is a Corporation Tax relief.

There are two schemes for claiming relief, depending on the size of the company or organisation:

• The Small or Medium-sized Enterprise (SME) Scheme
• The Large Company Scheme

This note focuses on relief for SMEs.

R&D relief is given in two different ways, by enhanced deduction or by payable credit. The amount of relief given depends on when the R&D expenditure was incurred:

In order to claim relief a company must meet the qualifying conditions:

• The company must have incurred a minimum of £10,000 of qualifying expenditure on R&D projects (this requirement is removed from April 2012).
• Intellectual property resulting from the R&D must vest in the company (this requirement has been removed but has still to be enacted – see Small print).
• The company must not be in receipt of a notified state aid in respect of the project.
• Expenditure must not be subsidised.
• The company must not have been contracted to carry out the R&D.
• The company must be a going concern.
• The R&D project must not receive total aid of more than €7.5m.

To claim relief:
• An R&D report should be submitted along with the company tax return as part of the tax computation.
• The principle activities statement to the accounts should state that R&D work is part of the company’s business activities.

Vacines - new restriction
The deduction available under Vaccine Reseach Relief for SMEs reduces to 20% from 1 April 2011, and 0% from 1 April 2012.

Overview And FAQs

SME companies that have incurred costs of £10,000 on qualifying R&D projects can obtain an uplift on these costs of 200%. It means that if a company spends £100, it will receive tax relief as if it had spent £200; prior to 1 April 2011 the rate was 175% (see Rates in At a glance).

Where a company has unrelieved trading losses it may surrender the R&D tax relief in exchange for a tax credit. The credit cannot exceed the company’s PAYE tax and NIC actually paid in the accounting period and where there are outstanding tax or NI liabilities the credit will be offset against these before any balance being refunded.

A claim for R&D must be made within two years of the end of the accounting period in which the costs were recognised.

What is an SME?

As of the 1 April 2008 the definition of an SME is taken as a company with employees of less than 500 and a turnover of €100 million or a balance sheet of €86 million. Prior to this the thresholds were 250, €50 million and €43 million respectively.

In the 2009 Pre-Budget the requirement that any intellectual property derived from R&D work was owned by the claimant company was abolished. This is to apply to accounting periods ending on or after 9 December 2009 and will be enacted in the 2010 Finance Bill.

Definition of R&D

R&D is defined in accordance with general accounting practice but is further modified by the guidelines produced by the DTI in 2004. In general there must be uncertainty that the final objective can be achieved and there must be an advance in science or technology through the resolution of scientific or technological uncertainty. The knowledge being sought must also not be already available in public domain.

Qualifying costs

The company must have incurred qualifying expenditure of £10,000 on R&D projects.

Government grant funding (notified state aid) provided for R&D projects must be excluded from any R&D claim.

Qualifying costs must have been incurred and cannot be of a capital nature. However, revenue costs that have been put to the balance sheet can still be included within the R&D Claim. Capital costs relating to R&D work qualify for capital allowances at 100%.

Qualifying revenue costs include:

• Staff costs (includes salaries, NI contributions, employers pension contributions but not benefits in kind to staff undertaking R&D work).
• Materials consumed or transformed.
• Water and fuel.
• Specially commissioned parts for prototypes.
• Software bought specially for R&D work.
• Subcontractor costs (unconnected third parties): the amount that can be included within the claim is restricted to 65% of the qualifying costs.
• Subcontractor costs (connected parties): the amount that can be included within the claim will be the lower of, the payment that is made to the subcontractor, and the relevant expenditure of the subcontractor.
• A proportion of variable overheads, see R & D claims and overheads.

The R&D report

A report should be filed as part of the company tax return as it is current HM Revenue & Customs (HMRC) practice to open an enquiry where no report is supplied. The report should include the following:

• A summary overview of the company’s business and the R&D projects being carried out.
• Commentary on individual projects. This should include details of what stage the projects are at, what the advances in science or technology are, why these are considered R&D qualifying, what the uncertainties are, and the hurdles that need to be overcome. This should also include a review of the current state of knowledge available within the particular field.
• Details of the staff and subcontractors being assigned to each project and their expertise.
• A summary schedule of the R&D costs splitting these into the categories of staff, consumables, etc.
• A schedule providing a detailed breakdown of how the expenditure included within the summary expenditure schedule has been arrived at.

Any reasonable method can be used when calculating the amounts to be included within the R&D claim for water and fuel, and staff costs. HMRC will generally not accept 100% of an employee’s salary costs within the R&D claim unless it can be clearly demonstrated. Costs of administration staff should not be included.

e.g.

Once there are no longer any uncertainties all costs after this point will not be considered as R&D qualifying by HMRC.

Where subcontractor costs have been incurred they can only be included within the claim where the subcontractor is involved in resolving a specific element of the R&D project. If the work carried out by the subcontractor is more general consultancy e.g. in providing an opinion, then this cost cannot be included within the claim.

Where a company has been contracted to carry out R&D work and cannot therefore make a claim under the SME rules it may be possible to claim under the large company rules. Where this is applies the uplift in costs is 135% and any trading losses cannot be surrendered in exchange for a tax credit.

Prototypes and trials

May 2011: according to KPMG, HMRC has changed its policy on allowing production expenditure on prototypes to qualify for R&D tax relief.

HMRC has not announced a change of its position but it has recognised that many companies and advisers disagree with its interpretation of what is excluded by the Department of Business Industry and Skills (DBIS) guidelines defining R&D. Accordingly HMRC has undertaken a programme of discussions with companies defending existing claims to see if principles can be agreed which would enable the HMRC position to be modified. If so, the guidance published by HMRC in the Corporate Intangible Research & Development manual would be amended. However there is no guarantee that such discussions will result in any change to HMRC’s position.

In the meanwhile HMRC have included the question of production expenditure in their consultation on possible changes to the R&D regime, so that if necessary they can address the subject going forward so as to make the position less uncertain. 

If you are engaged in manufacturing and have been discouraged from making R&D claims in respect of prototypes or manufacturing trials, or you believe you undertake prototyping or manufacturing trails, there may be an opportunity to make claims for R&D Tax credits.

Small print and links

The provisions relating to R&D Relief are found in Part 13 (sections 1039 to 1142) of the 2009 Corporation Tax Act.

HMRC’s guide to R&D Relief: http://www.hmrc.gov.uk/ct/forms-rates/claims/randd.htm

Links to policy changes on Variable overheads.

Removal of requirement that IP is owned by claimant source: enacted in Finance Act 2010.