A Clean Break

How R&D Tax Credits Work - Will Taylor

Few would argue that the UK is a tax haven, and many feel it lags sadly behind more enlightened tax regimes such as Canada. However, there still remain nuggets of benefit to be mined from the complex and ever-changing UK tax legislation.

Though often referred to in headlines, the Research & Development Tax Credit system currently in operation in the UK, is not the widely well-understood. It would appear that, in particular, many start-ups in the technology sector fail to exploit the real and immediate financial benefits it has to offer, at a time when they desperately need them.

So What is it?

R&D relief is a Corporation Tax relief (and so only available if you are subject to Corporation Tax). It allows you to reduce your company's tax bill by more than your actual tax allowable expenditure on R&D.

If you are a large company, you can now get 130 per cent tax relief on your R&D expenses, while if you are a small or medium company (SME), you can now get 175 per cent tax relief. SMEs are defined as having less than 500 employees and either turnover of less than EUR 100 million or an annual balance sheet figure of less than EUR 86 million.

If you are a loss-making SME you can also sacrifice your loss (to the extent it relates to R&D costs) and get a 'cash tax credit' for this loss. To qualify for R&D relief a company must spend at least GBP 10,000 on qualifying R&D expenditure.

What is "Qualifying R&D Expenditure"?

HMRC guidelines state: "R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology... the activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D".

So, yes, sufficiently vague and generic, but given that this is a tax break to encourage innovation, it would be inherently difficult to define R&D categorically. This is a problem as companies wishing to take advantage often find it difficult to establish whether they qualify. It is also, arguably, a great opportunity to put forward a case for what is R&D, for the very reason that the definition is so broad.

HMRC has to judge each case on its own merits (they have dedicated R&D departments throughout the country) and so the definition of R&D in each specific context is always evolving. The key then is to define the "activities that contribute to this advance" and then try and link in all the expenses that both make up and are ancillary to these "activities".

In some cases this is relatively easy. For example, if you devote one week a month of staff time to pure R&D then you might claim that percentage of the staff cost for those partaking in the R&D. In other situations R&D is more difficult to define - if you are developing a new aerodynamic bicycle, then the cost to design and build the frame and components would likely be R&D, but so might the software you purchased (or created) to test its drag, and the staff time employed to perform these tests.

It often helps, therefore, to set out the basis and justification for your claim, in addition to submitting the amounts for which you want the enhanced relief. Subjective as the process can be, HMRC does however provide a definitive list of expense categories that can be claimed for. These include the following -

• Expenditure must be revenue rather than capital
• Expenditure must be related to the trade carried on by the company
• It must be incurred on the relevant (and appropriately apportioned) staff costs: software; relevant payments to the subjects of clinical trials; consumable or transformable materials; subcontracted R&D costs or externally provided workers

To further define, staff costs include all National Insurance but do not include Benefits in Kind, and externally provided workers are typically restricted by 35 per cent in the claim.

And - as mentioned by Alex - until this week there was also the strict requirement for SMEs that the intellectual property resultant from the R&D must vest in the company, but the PBR dispensed with this restriction.