Businesses in the UK can claim a research and development (R&D) tax credit to help offset costs associated with qualifying R&D activities. The amount of the credit is based on a percentage of qualifying expenditure and in order to be eligible for the credit, businesses must follow specific guidelines and complete a number of steps.
This article will provide an overview of 6 core aspects of preparing a research and development tax credit claim.
1. The basics of a research and development tax credit
R&D Tax Credits are a corporation tax relief that can provide cash benefits of up to 33% of qualifying expenditure incurred for certain activities, depending on the scheme you claim under - more on this later.
The tax relief offsets the cost of your company’s research and development efforts. It was introduced as an incentive for businesses to invest in innovation, allowing them to realise additional cash resources so they can further develop their products, processes or services as they strive to overcome scientific or technological uncertainty.
This means businesses are able to claim back a portion of the money spent on eligible costs relating to R&D-specific projects including employee wages and work subcontracted to external companies. We'll dig into these shortly!
Research and development (R&D) is crucial for businesses looking to innovate and stay ahead of the competition. If your business invests in R&D, you may be able to claim a research and development tax credit (R&D Tax Credit).
2. What is eligible for the R&D Tax Credit
There are a number of eligibility criteria your company must meet in order to claim the R&D Tax Credit:
- Company: Your organisation will be a UK trading company that is subject to paying UK corporation tax.
- Purpose: Your organisation is creating or making changes to products, materials, devices, processes or services.
- Focus: You will be founding something that doesn't exist, improving what does exist or duplicating something in a different way.
- Problem solving: Your organisation is looking to find solutions to challenges that have not yet been solved by your industry.
- Basis: Your project explores the application of scientific or technological principles relevant to your industry.
- Financial outlay: Your organisation must have incurred costs to fund the activities assisting with problem solving.
The main one is that you must be undertaking qualifying research and development activities for the purpose of generating new or improved products, processes, devices or services.
A common misconception is that R&D has to be for new 'inventions' but it can also be claimed for work carried out on improving an existing product, process, device or service as long as it results in new or improved scientific or technological knowledge or capabilities.
Almost every industry has ways of undertaking R&D activities, however, some are naturally more inclined to do so. In my experience, the top 4 industries are software development, manufacturing, engineering and pharmaceuticals. Each of these has its own subset of typical R&D activities...
R&D activities in software development
As a fast-paced, forward-thinking sector, the software development industry sees a wealth of qualifying activities in R&D:
- Creating proprietary software
- Building middleware or tools to extend the functionality or performance of an existing system
- Designing methods to consolidate underlying disparate systems
- Integration of third-party software and/or hardware
- Data capture and transformation
- Resolving incompatibilities in sought after technology stacks
- Customising out of the box technologies
R&D activities in manufacturing
Not surprisingly, around one-quarter of all R&D tax credit claims are made annually by this sector as it strives to develop machinery, processes, operations and product development:
- Seeking significant gains in productivity, quality or environmental outcomes
- Creating notable improvements to product attributes e.g. quality
- Seeking to incorporate new materials, formulations, substrates, methods and techniques in processes
- Creating substantial improvements in capabilities e.g. accuracy or repeatability
- Improving safety, energy efficiency or reducing environmental impacts
- Resolving system uncertainty through a holistic approach
R&D activities in engineering
From electrical to mechanical, marine to aerospace, engineering plays a crucial role in technical problem solving - R&D tax credits reward this:
- Experimental design iterations aimed at improving performance, reliability, quality or safety requirements
- Overcoming environmental or spatial constraints
- Developing solutions to accommodate mechanical components
- Improving structural schemes and construction techniques
- Combining technologies to work in a way they were not originally intended
- Improvements to speed, yield, strength, longevity, tolerance, throughput, etc.
R&D activities in pharmaceuticals
The science and medicine sector is growing exponentially as we search for innovative solutions to new diseases and illnesses, making this a hotspot for R&D activities:
- Experimental testing methodologies
- Finding out how to predict outcomes of therapeutic agents
- Developing new compounds to duplicate the effects of patented drugs without infringing patented traits
- Seeking approaches to incorporate compounds into new formulations that were not previously possible
- Modelling and simulation of chemical modifications
- Overcoming issues with absorption
- Developing models to scale up experimental methodologies
Once you've decided whether your business is undertaking a qualifying activity, the next step is understanding exactly what expenditure is eligible for tax relief under the 5 core areas. We'll not go into depth on each here as we have a whole article dedicated to these:
- Staffing costs
- Software and consumable items
- Externally provided workers
- Payments to qualifying bodies
- Contracted out R&D
3. How to calculate the amount of your claim
It's important that you accurately calculate the amount of your claim - the last thing you want to do is claim too much or too little tax relief. Too much and you could be asked to repay it; too little and you won't be properly reimbursed for your R&D efforts.
Although the amount you can claim will differ under each scheme - RDEC or SME -the calculation process will remain the same…
Outlining qualifying expenditure
It is important to reference all the qualifying projects on which your claim is based. Be sure to define the advances to demonstrate a clear link to the BEIS guidelines for R&D.
Challenges should also be described to evidence uncertainties; it is the technological input rather than the commercial output that matters when describing an advance and challenges. This means that even if your R&D project has an 'unsuccessful' outcome, you can still claim for the journey of discovery.
Apportioning expenditure to R&D
A common mistake made when filling in an R&D tax credit is incorrectly apportioning salary costs, software purchases or other overheads.
It's unlikely that 100% of your organisation's time and efforts are spent solely on R&D activities so it's important that only the costs associated with the R&D aspect of your business' activities are included. Make sure you go through your expenses with a fine tooth comb to work this out.
As an example, imagine you have 5 members of staff each earning £50,000. That's £250,000 expenditure on salaries…
However, each staff member only spends 80% of their available working hours on R&D activities. This means you can only claim for 80% of each person's salary; £40,000 per person. This makes your qualifying staff expenses £200,000, as opposed to £250,000.
4. Working out the right scheme to claim under
There are a number of aspects that need to be considered collectively to work out whether the RDEC or SME scheme applies to your company.
SMEs are defined by their size based on:
- Employee headcount (fewer than 500 employees) and
- Falling below either the annual turnover threshold of €100m or the gross assets threshold of €86m.
Whilst the RDEC scheme applies to all projects undertaken by companies that do not meet the SME criteria. There are also various other criteria that may make it necessary for an SME to claim under the RDEC scheme for some or all of its qualifying projects.
Depending on the scheme you claim under, the financial rewards will differ:
- SME: rates of relief can result in financial benefits worth between 25% and 33.35% for every £1 of qualifying expenditure identified, depending on whether the claimant company was profit-making or loss-making in the relevant tax year.
- RDEC: the tax/cash benefit is currently 10.53% for every £1 of qualifying costs.
5. Writing up your tax credit report
After you've discovered whether your business is eligible for R&D tax relief, listed out your qualifying R&D expenditure and figured out which scheme to claim under, you'll need to write up your technical report to submit with your claim.
An R&D tax credit claim report can be anywhere from 12-30+ pages long and should include the following:
I've written a handy step-by-step guide - How to put together an R&D tax credit claim that stands up to HMRC scrutiny - that will take you through piecing together your report.
6. When you should file your claim
Once everything is in place, the final step, of course, is filing your R&D tax credit claim.
As you'll have discovered, the entire process for putting together your R&D claim can take time depending on its size and complexity. You'll also need your company accounts and tax return to be prepared so you can submit your R&D claim as part of this electronic filing bundle (i.e. the R&D claim is part of your company tax return), so make sure you're prepared well in advance of any deadlines.
A company has 2 years from the end of its accounting period to file an R&D tax credits claim with HMRC. You can also amend your CT600 to include an R&D tax credits claim for up to one year from its filing deadline. So, if you've already submitted your corporation tax return for a financial year that you need to claim tax credits for, don't worry, it's not necessarily too late!
Finding support with your R&D claim
Obtaining financial evidence and writing an R&D tax credit claim can take time, especially if you have a lot of qualifying work taking place. Company circumstances or contracts can add further complexity when looking to apply the tax rules in this area, so it's worth considering working with a specialist R&D tax adviser.
I help business owners and financial directors claim the R&D tax credits their organisations deserve. Working with companies of all sizes and across various industries, I prepare R&D tax credit claims to accurately portray company activity and maximise financial benefits.
If you're ready to get started on yours, book a call to discuss your R&D eligibility.