This is everything you’ve ever wanted (or not wanted) to know about the R&D tax credit in the UK, we’re not kidding. This Guide contains everything we know about this most excellent tax incentive, still, if you want to have a leisurely ride through HMRC’s process and make sure you’re getting every penny you’re eligible for, it may be worth getting a specialist on your side. There are hundreds of companies specialising in helping you navigate these waters, and it’s clear why – the R&D tax credit is complicated, and there is lots of taxpayer money on the line. To help us verify our facilities, we partner with the best of the UK’s R&D providers. Feel free to chat with us if you’d like a no-obligation intro.

The UK has one of the most successful Research and Development (R&D) tax credit frameworks in the world. The European Commission highlighted this framework for its broad eligibility criteria for tax credits. Unfortunately, it seems that not enough companies are applying to these schemes, even though they are eligible to do so. It may be that you are eligible, even if you don’t think you’re conducting R&D. As always, it often pays to chat with a specialist to get a free assessment.

In this Guide, we provide detailed information to make it clearer to companies when they can claim under the R&D tax relief schemes. We explain how the United Kingdom’s R&D tax relief framework operates and answer a range of frequently asked questions relating to it. Specifically, we:

  • Introduce the two different R&D tax relief schemes available in the UK;
  • Explain how R&D tax credits work;
  • Identify the current R&D tax credit rates;
  • Identify the sorts of activities and projects that will qualify for R&D tax relief;
  • List the different expenses that can be claimed as R&D;
  • Explain the process for claiming R&D tax credits;
  • Explain how to produce the technical narrative to support an application for R&D tax credits;
  • Demonstrate how the R&D tax credit can be calculated;
  • Show how the R&D tax credits interact with other types of State aid;
  • Look at whether there is any template that can be used for the purpose of making this application;
  • Work through the advance approval process for R&D tax credits;
  • Explain how governmental measures in response to COVID-19 affect R&D tax credits.

R&D tax relief (we use this interchangeably with the term ‘R&D tax credits’) is available to ‘limited companies’ (we’ll just call these ‘companies’ from this point on), in the UK. This means that it is not available to all businesses in the UK (such as sole proprietors, partnerships, or unlimited companies). The current tax rate for companies is 19%, and tax relief schemes are applied to the final tax burden.

The R&D tax credit schemes have evolved and changed continuously over the last 20 years since the schemes were first introduced. Because of this constant change, it is always important to seek up-to-date information (like this Guide!).

First, a little trip down memory lane. Before its introduction in 2000, the predecessor to the UK’s R & D tax credit schemes was the Scientific Research Allowance (‘SRA’). The SRA was a form of tax allowance for capital expenditure (e.g., investment in scientific equipment), which allowed full depreciation of the expense in the first year. Since its introduction in 2000, the R&D tax credit framework has arrived at two separate schemes:

  • The Small and Medium-Sized Enterprise (SME) Scheme (the SME scheme). To be eligible for this scheme, the company must have less than 500 staff and a turnover of under 100 million euros, or a balance sheet total under 86 million euros, and
  • The Research and Development Expenditure Credit scheme (the RDEC scheme, formerly known as the ‘large company scheme’). RDEC is available to both large companies and SMEs who have been subcontracted to do R&D work by a large company (more on this below). Note also that the RDEC scheme permits companies that are members of corporate groups to surrender their RDEC against the tax liability of another member of the group.

Both schemes operate similarly: They reduce the taxable company income by an amount which is proportional to R&D expenditure in the company. The overall effect, for tax purposes, is either a reduction in the company’s income, or, where it is loss-making, an increase in the loss. Where the company is loss-making, the R&D tax credit can either be carried forward as a loss in the next year, or taken immediately as a cash payment.

One big difference between the two programmes is that the SME scheme is more generous than the RDEC scheme. Note, however, that the RDEC scheme works better when a company also has other separate State R&D grants, so, in some cases, this scheme can be more lucrative.

rd tax credits
Photo by LYCS Architecture on Unsplash

How do R&D tax credits work?

As mentioned, R&D tax credits can be applied to either profit-making or loss-making companies to reduce the tax burden of the business. They can be taken either as a cash credit or a current or future tax offset. The SME scheme applies a formula that allows up to 33.5 percent of a company’s spending on R&D to be claimed back. The RDEC Scheme works similarly, but the rates are lower, allowing the company to claim around 9%

HMRC defines R&D as:

“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.”

The great thing is that, under this definition, you don’t need to be doing ‘rocket science’ to be eligible for R&D tax credits. The definition is ‘area’ or ‘project’ agnostic, covering a very broad range of possible activities. We discuss these different possibilities in more detail below.

how do rd tax credits work
a. Caption: Photo by Leon Dewiwje on Unsplash

What kind of work will be eligible for R&D tax credits?

work eligible for RD tax credits
Photo by Jonas Morgner on Unsplash

In the government’s guidelines explaining the R&D scheme, the definition is kept a little vague, so there is still some room for interpretation. Because the scheme has been going on for two decades now, advisors and qualifying companies have started to understand what HMRC’s intention is, and here are the main points:

  • The advance in science or technology must be in the overall state of knowledge or capability in the world, not just that state as it exists in one company. This can include adaptation from another field, where this adaptation was not easy or straightforward to make; This means: the technology must be new to everyone, not just to your company.
  • The advance might have tangible results (e.g., a new product) or intangible outcomes (e.g., new knowledge or cost improvements). It may also be an ‘appreciable improvement’ to an existing activity, or use science or technology to duplicate the effect of an existing activity; This means: HMRC is not just looking for giant leaps in technology with clearly defined outcomes – you can have incremental innovation, even processes without clear results, you just need to have overcome technical uncertainty. 
  • An activity does not involve an advance in knowledge, simply because science or technology was used in performing that activity;
  • It doesn’t matter if the advance in question is ever actually achieved, trying is enough.
  • Even if an advance has already been made by another company or entity, as long as that information is not readily available, R&D in this area may still constitute an ‘advance’; This means: If you can’t access the solution to your problem even if it was developed by someone else, solving that problem is R&D. 
  • The qualifying R&D activities must contribute to achieving the advance through the resolution of scientific or technological uncertainty. This does not include uncertainties that can be solved by a competent professional working in the field. This means: If it is a routine, maintenance or google-able activity, then it is not R&D. 

Which activities might be eligible for R&D tax credits?

If you remember the definition we set out above, it’s clear that qualifying R&D may cover a wide range of different activities in different fields.

Some possibilities include:

  • Software development. For example, the development of a new virtual reality gaming capability;
  • ICT hardware development. For example, the development of new firewall hardware;
  • Engineering design. For example, the development of a new packaging design with a unique chemical structure;
  • New construction techniques. For example, different eco-friendly roofing materials could be in development;
  • Bio-energy. For example, the development of a new type of car engine fueled by biomass;
  • Cleantech. For example, the development of new energy-efficient appliances;
  • Agri-food. For example, a project to develop crops more tolerant to climate change;
  • Life and Health sciences. For example, the development of a COVID-19 vaccine.

For more information on all the kinds of activities that might be qualifying R&D, see Research and development tax relief: Making R&D easier for small companies.

What counts as R&D costs for the purposes of the schemes?

Once you have figured out that the company’s activities will, at least in part, qualify as R&D, it is essential to work out exactly which expenses will qualify for a claim. An important thing to remember is that the costs that can be claimed usually relate to operational expenditure (like, for example, salaries for software developers), not capital expenditure (like, for example, improvements to a plant).

The qualifying categories for eligible R&D include:

  •       Direct R&D staff costs. This includes gross salaries and wages, pension contributions, employer insurance contributions, and reimbursed business expenses. Note, these costs can only be counted where they relate to the employees actually doing the R&D work, as well as a proportionate amount of supervisory or management time;
  •       Externally provided R&D staff. These are the costs paid to an external agency for those directly involved in R&D. R&D tax credits are usually restricted to 65% of the payments made to the agency;
  •       Subcontracted R&D. The company can usually claim 65 percent of payments made to an ‘unconnected’ party under the SME scheme who works on R&D (the rules are different if the subcontractor is connected). Under the RDEC scheme this is generally not allowable as a qualifying expense (though there are some exceptions);
  •       Consumables. Anything that you consume in the process, such as power or materials, can be part of your claim. Note, the expenditure must relate to resolving the uncertainty at the heart of the R&D activity. Any cost after that point (e.g., the materials in the products actually sold), cannot be claimed;
  •       Software directly used in R&D. Only software directly involved in R&D can be claimed. Where the software was partly used for R&D and partly for other activities, the cost can be apportioned;
  •       Clinical trial volunteers. If trialing interventions and making payments to participants, this can be claimed under some circumstances;
  •       Contributions to independent research. Only large companies can claim this under the RDEC scheme. This would cover, for example, funding provided to a higher education institute;
  •       Prototypes. These are R&D, where created solely to test the solutions being developed. However, if the prototype is to be sold as a product, it does not qualify;
  •       Collaborative working. It is common for companies to collaborate with other entities, people and institutes on R&D. Note, however, that the R&D needs to be apportioned to each entity and there can be no ‘double-counting’;

And as the last point, importantly, the expenditure must have occurred within the last two complete financial years. You can only claim expenses that have been incurred in the last two completed financial years. Anything spent beyond that time horizon is not claimable.


Which costs do not count for R&D tax credits?

production of goods
Photo by Rob Lambert on Unsplash

While, in some cases, it will be a judgement call, and it can be good to seek professional advice on whether an expense could be qualifying R&D, certain expenses will definitely not count. This includes:

  •       The actual production of goods and services to be commercialised;
  •       Capital expenditure. If you decide to capitalise R&D expenditure, that may be a good decision in your particular circumstance. Just note that these expenses will then not be eligible for R&D. But note there is a separate Research and Development allowance that can be used to claim the depreciation on assets used for R&D activity;
  •       Land costs;

·        Payments for the cost of patents and trademarks (as these occur after R&D is complete). There is a separate Patent Box scheme in the tax return, which allows companies to apply a ten percent tax rate to profits from patents.


How do I claim R&D tax credits?

claiming rd tax credit
Photo by Dylan Gillis on Unsplash

Though if you are looking for R&D financing, we always recommend you work with a reputable R&D tax credit advisor, you can, of course, also self-file your tax credit application.

There are three essential elements:

  • Filling in your company tax return (CT600);
  • An explanation as to how your activities meet the requirements for claiming the tax credit. This is often referred to as a ‘Technical Narrative’;
  • Calculations to explain how you arrived at the final amount.

How do I write the technical narrative?

This is the tricky bit. Here you need to come up with an explanation as to how your spending meets the R&D qualifying requirements. If you can give a convincing case, the chance that HRMC will raise an enquiry is low. In your technical narrative, you should make sure you include:

  • Background information relating to your company. Demonstrate how R&D relates to your business as usual;
  • Identify clear project(s) for which you want to claim R&D tax credits. Ideally, you should have several separate mini-case studies;
  • Set out your timeframes for the projects (this clarifies that the project qualifies);
  • Explain the technological or scientific advances that your projects were intended to solve. Not all research activities involve science or technology (e.g., social science and humanities research);
  • describe the scientific or technological uncertainties that were encountered. Remember, this must be something that cannot be readily overcome by a competent professional in the field. It may be relevant to identify what others (such as rival companies) are doing to overcome these uncertainties;
  • walk through how, and when, the identified uncertainties were overcome. The methods used should be described, and if there was a failure to overcome those uncertainties, this must be explained;
  • explain why the knowledge being sought was not readily deducible by competent professionals. Here you should explain the current state of the research. You should outline the qualifications and background of R&D professionals in the company, and have them explain why the uncertainties were not merely ‘routine’;
  • list any obstacles that you faced in pursuing the R&D projects;
  • refer to the resources that you used in carrying out the project (e.g., software, hardware, consumables, staff, and subcontractor resources);
  • note the outcome(s) of the project. Keep in mind that the project does not need to actually succeed in order for expenses to qualify.

If the technical narrative is done well, this means:

  • A reduced chance of enquiries from HMRC following up on whether the projects qualify;
  • Speeding up the process of approval.

The HMRC aims to pay 95 percent of claims within 28 days.

To increase your chances of success, it may be worth considering the services of am R&D tax relief advisor.

writing technical narrative
Photo by Product School on Unsplash

Can I use an R&D tax credit claim template for SMEs?

We wouldn’t recommend it. The SME Scheme is dependent entirely on making new advances and resolving existing uncertainties. This means there is generally a lot of variation in these applications. It can be a good idea to seek professional advice on whether you are eligible for R&D tax credits.

small medium enterprises

How is the R&D tax credit calculated?

The R&D tax credit is applied slightly differently depending on whether the company is profitable or is making a loss. We consider both possibilities below:

Consider the following case of a company that had £100,000 of profit, and £20,000 of R&D expenditure incurred:

£100,000: Profit, before R&D

£46,000: R&D deduction (£20,000 x 230%)

£64,000: Amended Profit

£12,160: Company tax liability (19%)

£6,840: Company tax saved.

The end result is around a 36 percent reduction in company tax paid.

What would the calculations look like if the SME made a £100,000 loss?

(£100,000): Loss

£46,000: R&D deduction (£20,000 x 230%)

(£146,000): Revised loss to which the 14.5% R&D tax credit rate for SMEs applies

£21,170: Tax credit cash benefit received.

Are R&D tax credits notifiable State Aid?

The R&D tax relief schemes are not the only government-support options for R&D. Also, there is a range of grants and subsidies available. However, when you decide which grants to take in conjunction with R&D tax credits, you must choose wisely: accepting grants can affect your ability to make an R&D tax credits claim.

The SME scheme counts as ‘notifiable State aid‘. As a consequence, this can affect the company’s use of a tax credit. If the grant in question is ‘notifiable State aid’, it cannot be received in addition to the SME tax relief. This covers, for example, Innovation Grants. Innovate UK awards these via a competitive process. The grants can vary between £25,000 and £10 million.

However, in this scenario, your expenditure will still qualify under the RDEC scheme. If there are multiple R&D projects, the company may make RDEC claims for projects that have State aid and SME claims for projects that were not funded by a grant.

Note that if the business has received a grant that is not notifiable State Aid such as de minimus State Aid, Horizon 2020 or Framework Programme funding, the company may be eligible to apply under both the SME scheme and the RDEC scheme. The RDEC scheme can be applied to any expenditure which is funded by the grant. Then, any R & D element that was not funded by the grant can be claimed under the SME scheme.

RD tax credit aid
Photo by Evangeline Shaw on Unsplash

How can I be sure in advance that I am eligible for the R & D tax credit?

As the R&D tax credit schemes are an incentive provided ‘after the fact’, how can your business engage in robust financial planning without knowing for sure whether you will be eligible for this relief? HRMC can help with its ‘Advance Assurance’ process. This process guarantees that R&D claims will be accepted as long as they:

  • Is the claimed R&D in line with what was previously agreed upon?
  • Was the claim made within the first three accounting periods?

To be eligible for Advance Assurance your company must be:

  • An SME;
  • Planning R&D or already have carried it out;
  • Not be linked to any companies that have made a claim before (e.g., in a corporate group).

You will be ineligible if you:

  • Have entered into a Disclosable Tax Avoidance Scheme;
  • Are a serial company tax-defaulted;

Information that you must provide includes:

  • Company accounts;
  • Company registration documents (from Companies House);
  • HM Revenue and Customs (HMRC) correspondence;
  • Previous company tax returns, where available;
  • The name of a contact with direct knowledge of your R&D who is available for discussion.

Once applied, HRMC will talk to you about it. They will then send you a letter confirming whether you have been successful or not. The letter will explain what to do if your R&D activities change.

You may be contacted after submission of the first claim for R&D tax credits to check a match with the details in your advance assurance application. Guidance on Advance Assurance is available here.


UK RD tax credits
Photo by Hugo Sousa on Unsplash

How do the UK R&D tax credits contrast with the Australian scheme?

Australia also has a R&D tax relief scheme. Businesses that are based in both the UK and Australia may wish to assess in which country it may be eligible to claim its R&D tax relief. Differences between the two frameworks include:

  • Administrative requirements. In Australia, a company must register for each year it wishes to claim the credit. Whereas in the UK, the company can simply claim its R&D tax relief in the course of its regular company tax return filing;
  • Australia uses a different definition of R&D which focuses on the testing of scientific hypotheses: it proceeds “from hypothesis to experiment, observation and evaluation, and leads to logical conclusions“;
  • Location. In the UK, R&D expenditure can be incurred anywhere. In Australia, the R&D must actually occur in the country in nearly all cases;
  • Standard of assessment of review. In Australia, a special governmental body ‘AusIndustry,’ determines which activities are eligible for relief. In contrast, in the UK, it is HMRC that reviews the documentation, and it likely has a less expert opinion on the activities;
  • It requires a minimum spend of $20,000; The Australian scheme increases the tax offset from 30 percent (the Australian company tax rate) to 43.5 percent for businesses with an annual turnover of less than $20 million. For companies larger than that, it is 38.5 percent.

You can find out more about this scheme here.



What is the impact of COVID-19 on R&D tax credits?

COVID-19 has had an impact on R&D tax credits. This results primarily from the fact that some of the funding provided by the government in response to COVID-19 is ‘notifiable ‘State aid’. For example, the Coronavirus Business Interruption Loan Scheme (CBILS) will impact on your ability to acquire R&D tax credits for that funded activity.

This means that you should seek professional advice on which mix of government aid, subsidies and tax relief is right for you.

Conclusion

There are two tax relief schemes available to companies in the UK, depending on their size: the SME scheme and the RDEC scheme. Either one may be worth applying for if your company is engaged in R&D activities and otherwise meets the size requirements. However, there is a range of matters you need to consider before applying for this scheme including:

  • Does the activity of your business count as R&D according to the regulatory definition?
  • Which of your activities might be claimed as R&D and which are either ineligible or being carried out by another entity (such as a subcontractor)?
  • Assess which expenses, relating to your R&D can be claimed. Note, not all of them can be. For example, patent or trademark costs are not qualifying expenditure;
  • You need to consider how the R&D tax relief schemes interact with State aid and grand schemes. This may affect your eligibility;
  • Work out your justification and explanation for R&D tax activities in the ‘technical narrative’ that is to accompany your company tax return;
  • If it’s your first time applying, consider whether it is worth getting ‘Advance Assurance’ to ensure that you will get the tax relief, come tax time;
  • Consider whether your access to any COVID-19 business support packages might affect your R&D tax situation;
  • Where you are eligible to apply in both countries, consider whether the Australian R&D tax relief scheme might be more beneficial.

We hope that you found this Guide useful, and If you think you could benefit from professional R&D tax relief advice, don’t hesitate to chat to us.


Alexandra Kepka

Alex is a tech-focused funding expert, helping innovative companies grow through innovative funding through her work at Fundsquire. She also has a background in journalism, having written for outlets like Vice and many others in the past on topics ranging from philosophy to economics.

Have a question?

Interested in learning more about us? Please get in touch today.

Contact us