R&D tax reliefs are crucial for driving innovation in the UK. They offer financial support for businesses investing in new technologies, products and processes and allow you to claim tax relief on qualifying expenditure. Understanding the differences between the Small and Medium-sized Enterprises (SME) R&D tax relief and the Research and Development Expenditure Credit (RDEC) for larger companies is key to getting the most out of your claims.
R&D Tax Relief Eligibility
To be eligible for R&D tax relief your company must meet specific criteria that ensures the relief is targeted at genuine innovation activity. Firstly, your company must be a UK based business and subject to UK corporation tax. This means your company must be liable to pay corporation tax in the UK and therefore eligible for the associated tax reliefs.
Your company must have incurred qualifying expenditure on R&D activities. These can include things like staff costs, consumables, software and subcontractor costs. It’s essential that these costs are directly related to the R&D project and not general business expenses.
Your company must also be a small or medium-sized enterprise (SME) or a large company. An SME is defined as a company with fewer than 500 employees and either a turnover not exceeding £100 million or gross assets not exceeding £86 million. If your company doesn’t meet these criteria then you are a large company.
Your company must have a qualifying project that meets the definition of R&D. This means the project must resolve scientific or technological uncertainty. The project must involve overcoming challenges that can’t be easily solved by professionals in the field. Please note that projects in the social sciences, arts, humanities or economics do not qualify for R&D tax relief.
SME R&D tax relief
The SME R&D tax relief is designed to support smaller companies in their innovation activity. The SME R&D tax relief scheme allows smaller companies to benefit from R&D tax credits which can reduce their tax liability. To qualify as an SME your company must have fewer than 500 staff and either a turnover of under £100 million or a balance sheet total under £86 million. This scheme allows SMEs to deduct an extra percentage of their qualifying R&D costs from their annual profit, on top of the standard 100% deduction which helps reduce their Corporation Tax. For loss-making companies there is an option to surrender the loss for a payable tax credit.
RDEC for Large Companies
The RDEC scheme is mainly for large companies but is also available to SMEs in certain circumstances such as when they have been subcontracted by a large company or received specific grants or subsidies. Unlike the SME scheme, RDEC provides a tax credit that is taxable and appears as income in the company’s accounts, giving significant corporation tax relief. This credit can be used to offset a company’s tax liability or in some cases result in a cash payment.
Qualifying Costs for R&D Tax Relief
Knowing what costs can be included in an R&D tax relief claim is key to getting the most out of it. Costs for externally provided workers, such as those incurred through PAYE and National Insurance contributions, can also be included in R&D tax relief claims. For both the SME R&D scheme and the RDEC scheme, businesses can claim relief on a range of costs directly related to research and development projects.
These include staff costs, such as salaries, pensions and National Insurance contributions for employees engaged in qualifying R&D activities. The time spent by employees directly involved in the project can be apportioned and claimed accordingly.
Companies can also claim for subcontracted R&D work, although the rules differ depending on whether the business is using the SME or RDEC scheme. For SMEs a percentage of subcontractor costs can be included, whereas large companies claiming RDEC generally can’t include costs for subcontractors unless they are part of a qualifying partnership.
Software development costs are also key, particularly for businesses that create or modify software for internal R&D purposes. This is especially relevant for tech-based SMEs that rely on new software innovations. Businesses can also claim for materials and utilities, such as power, water and fuel used in the R&D process. However these costs must be directly related to the project and not general business overheads. The rules around consumable items can be complex but they typically include items that are used and transformed in the R&D process.
Recent Trends and Statistics
Decline in claims – Total R&D tax credit claims decreased by 21% from around 83,000 in 2021/22 to approximately 65,000 in 2022/23. SMEs saw a 23% drop in claims, while RDEC claims fell by 9%. Despite the fall in claims, claiming an R&D tax credit is still a big benefit for businesses.
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Increase in average claim value – Despite the fall in claims, the total amount of R&D relief claimed remained at around £7.5 billion. This was due to a 26% increase in the average claim value within the SME scheme, meaning larger claims were concentrated in fewer businesses.
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Sector breakdown – Information & Communication, Manufacturing and Professional, Scientific & Technical sectors accounted for 66% of all claims and 70% of the total amount claimed, so these industries are the biggest users of the scheme.
Compliance Measures
The decline in claims is mainly due to HMRC’s increased compliance measures to reduce fraud and error. These measures ensure each tax claim is thoroughly checked, reducing the risk of fraud and error. New requirements such as the Additional Information Form (AIF) and pre-notification processes have made the claims process more rigorous. While this has added extra work for businesses, it has also means only legitimate claims are processed.
R&D Relief in Different Industries
The types of projects that qualify for SME R&D tax relief or RDEC relief vary by industry. Projects that resolve scientific or technological uncertainty qualify for R&D tax relief, regardless of industry. Many businesses overlook eligibility because they assume R&D is only for science and technology companies. While pharmaceuticals, engineering and software development businesses are some of the biggest claimants, R&D tax relief is available across many sectors.
In manufacturing businesses can claim relief for developing more efficient processes, new materials or improved products. The food and drink industry can claim R&D tax relief for new recipes, improving food preservation techniques or reducing waste in the supply chain. Even construction firms can claim SME R&D relief for developing sustainable materials or innovative designs. The creative industries, including video game development, film production and digital marketing can also qualify if they are solving technological challenges.
For example a business developing a new animation tool to enhance digital rendering may be eligible. With the rise of AI and automation companies across many sectors are investing in research to optimise workflows, reduce costs and enhance customer experiences. These activities could qualify for relief if the right circumstances.
Regional Variation
R&D claims are concentrated in companies with offices in London and the South East which account for 38% of all claims and 50% of the total amount claimed. This regional imbalance suggests more awareness and support may be needed to encourage R&D in other parts of the UK.
Changes to R&D Tax Relief
From April 2024 the government merged the SME and RDEC schemes into a single R&D tax relief system. These changes will affect accounting periods starting on or after April 2024 so companies will need to review their R&D activities and claims. This simplified the claims process and control costs. However the changes introduced new rules around subcontracted R&D and eligibility criteria so companies needed to review how these impacted their claims.
Common mistakes when claiming R&D tax relief
Businesses miss out on valuable tax relief due to common errors in their claims. One of the most common mistakes is not understanding what constitutes R&D. Many assume unless they are creating a new product they are not eligible. In reality R&D tax relief applies to a wide range of activities including process improvements and software enhancements. Failing to correctly identify the projects that qualify can result in missed opportunities.
Accurate documentation is key for tax purposes so all claims must comply with HMRC guidelines.
Another common error is not keeping proper records. HMRC requires businesses to provide clear documentation of their R&D activities including project descriptions, cost breakdowns and technical challenges faced. Businesses that do not keep detailed records may struggle to justify their claims and may face delays or rejections.
Businesses also overclaim by including costs that do not qualify. For example general admin expenses, marketing costs and routine maintenance work are not eligible. Incorrectly claiming these expenses can lead to HMRC enquiries which may result in reduced claims or penalties.Timing is another problem. R&D tax relief claims must be submitted within 2 years of the end of the accounting period in which the R&D expenditure was incurred.
Businesses that miss this deadline lose the opportunity to claim. Also with the recent compliance changes businesses now need to provide more information upfront so late or incomplete submissions will be flagged for further review.
How to claim R&D Tax Relief
Claiming R&D tax relief involves a detailed process and requires accurate documentation and adherence to HMRC guidelines. To start a company must submit a claim to HMRC detailing the qualifying expenditure incurred on R&D activities. This includes information about the company’s accounting period and corporation tax liability.
A vital part of the claim is the technical report. This report should describe the R&D activities undertaken and explain how they meet the definition of R&D. It must detail the scientific or technological uncertainty that the project aimed to resolve and demonstrate that the work was genuine innovation and problem solving.
In addition to the technical report a costing report is required. This report should provide a detailed breakdown of the qualifying expenditure incurred on R&D activities. It should include specifics on staff costs, consumables, software and subcontractor costs. Accurate and thorough documentation is key to supporting the claim.
The claim must be submitted using the Company Tax Return accompanied by the technical and costing reports. It’s also important for the company to notify HMRC in advance if they intend to claim R&D tax relief. This pre-notification helps the process and ensures HMRC is aware of the company’s intentions.
By following these steps and providing detailed documentation businesses can claim R&D tax relief and benefit from the financial incentives for innovation.
We can help
Understanding the differences between SME R&D tax relief and RDEC is crucial for businesses that want to maximise these incentives. Keeping up to date with the latest trends, compliance requirements and changes will help businesses manage their claims. At Plus Accounting we help businesses navigate these tax reliefs so they can benefit from the financial support for innovation.
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R&D Blog Series
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**1 Certain restrictions can apply to the amount of the loss refunded, your accountant can advise you in your specific circumstances.
Disclaimer – Please be aware that the information provided in this article only applies up to 31 March 2023.
Author: Helen Griffiths, Accounts and Audit Manager, Plus Accounting
Any views or opinions represented in this blog are personal, belong solely to the blog owner and do not represent those of Plus Accounting. All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site