The Ultimate Guide to the R&D; Tax Credit in 2021

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.

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.

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.

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.

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.

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.