The route to relief under the R&D tax relief regime is not always available/immediately accessible, even for companies where there is no question over the eligibility of their work, such as pioneering work in the life sciences space.
It is the tax rule base and the nuances within that which mean careful consideration should be given before entering into collaborations driven by funding needs around how to structure this to balance the tax position with the commercial position.
R&D tax relief is a scheme intended to deliver funding to support innovation in the UK. For Life Sciences companies operating in the Pharma, Biotech, Medtech spaces, knowledge of this tax relief and the cash funding benefits it brings is, I'd have thought, widespread.
This tax relief has been available for a long time and the Life Sciences industries are an obvious intended beneficiary of this.
However, despite the obvious connection of this relief with the work carried out in the Life Sciences space, this tax legislation doesn't necessarily have the same application for all companies that are part of this industry.
You cannot assume that your company can access R&D tax relief solely based on being a Life Science company.
Roadblocks to your route to relief may be present owing to things like:
- Ownership of your company
- How the work is funded
- What types of costs are incurred
This case study looks at how eligibility criteria, other than the nature of work, impacts the ability to access funding via this tax relief.
- In order to make a claim for R&D tax relief, a company needs to have “relevant R&D”. “Relevant R&D” is R&D which is related to a trade carried on by the claimant company or from which it is intended that a trade to be carried on by the company will be derived.
- The key thing appears to hinge on whether any third party licencing arrangements in respect of the Project IP, which may be entered into at some point in the future, will be entered into by LSUK directly with the third party and income received therefrom by LSUK.
- Clauses 8.6, 8.7 and 8.8 of the Research Collaboration Agreement seem to suggest that on the exercise of the ANON Option, it will be ANON directly negotiating with a third party in respect of a licence over the entire Project IP. It is not at this time known how any such contract would be structured.
- With regard to the 50% of the Project IP that vests with LSUK. If it is intended that there would be a licencing agreement negotiated for a contract between LSUK and a third party, with income derived therefrom that would be received by LSUK, there is a clear link between the expenditure incurred by LSUK on R&D activities and the benefit to its trade.
- It is assumed that in the event the Option is not exercised such that LSUK is free to negotiate a licencing arrangement with a third party for its share of the Project IP in accordance with Clauses 8.9 and 8.10, that LSUK would contract directly with that third party and income be received by LSUK in respect of that licence. In this instance, again there is a clear link between the expenditure incurred by LSUK on R&D activities and the benefit to its trade.
- Regardless of whether or not the ANON Option is exercised, the issue with respect to the 50% of Project IP that vests with ANON, is that it could be argued that 50% of the development expenditure should be excluded from any R&D tax relief claim as 50% of any future revenue stream derived therefrom cannot benefit LSUK’s trade. Whether or not HMRC would take the point is impossible to say.
Which R&D scheme?
- LSUK is an SME. It has one 100% shareholder, Founder.
- Notwithstanding LSUK’s status as an SME, LSUK is only eligible to make an R&D tax relief claim under the R&D Expenditure Credit (“RDEC”) Scheme for Large Companies. This is because it is receiving funding for the development work and currently, it appears to be the intention that the development work will be funded in its entirety by ANON.
- Under the RDEC Scheme, currently, LSUK will receive an effective cash tax benefit of 10.53% for every £1 of qualifying expenditure incurred. From 1 April 2023, the effective cash tax benefit may increase to 15%.
- RDEC works by allowing LSUK to recognise a taxable credit of 13% (20% from 1 April 2023) of qualifying R&D expenditure in its accounting profit (an Above The Line Credit).
- It is likely that LSUK will initially be loss making in the early phases of its development work.
- Relief is available for loss making companies under RDEC but is subject to a number of restrictions. The restriction to the PAYE liability of a company for the claim period is currently, and for the foreseeable future, detrimental to LSUK. As LSUK does not have any employees, it does not have any PAYE liabilities and as such, it cannot access the repayable cash credit. R&D tax relief is not lost, but it will be deferred until LSUK begins to make taxable profits in a future accounting period.
- LSUK is an SME. It has one 100% shareholder, Founder.
- Notwithstanding LSUK’s status as an SME, LSUK is only eligible to make an R&D tax relief claim under the R&D Expenditure Credit (“RDEC”) Scheme for Large Companies. This is because it is receiving funding for all the development work.
- LSUK currently has no employees.
- Founder is responsible for the day to day project management of the development work and also works on the development project directly.
- Currently, Founder is required to commit 2 days per week to the project, which is set to increase going forward. Founder is not currently remunerated for their time commitment. It is possible that Founder will be remunerated at some future point for their time commitment to the development project. Founder could be remunerated as a third party consultant, or be employed by Founder.
- If Founder is remunerated as a third party consultant under a contract for services, it is understood that this would most likely be via Founder’s personal service company (hereinafter referred to as “PSC”). In this case, Founder would be sub-contracting its R&D to PSC and cannot include such costs in its R&D claim under RDEC.
- If Founder were to be employed by LSUK under a contract of service, then a proportion of his qualifying remuneration may be included in the R&D claim.
- It is generally not possible to claim for external third party subcontractor costs under RDEC.
- Costs relating to bodies qualifying as Contract Research Organisations (“CRO”) may qualify. This would need to be considered further to ensure an Organisation contracted meets the criteria to qualify as a CRO for R&D tax relief purposes.
Benefits of R&D tax relief as a funding source
If you have recently started a new company, you may not have heard of R&D tax relief or if you have, have not yet taken the time to consider whether it could be relevant to your business.
In a nutshell, this is a long standing tax relief for UK companies, particularly aimed at supporting growth in the science and tech industries.
UK companies have come to rely on this tax relief as a valuable source of funding to supplement other funding sources (grants, business loans, angel investors for example).
The key benefits of this source of funding are:
- Timely - claimed in line with your company's annual accounting period
- Repeatable - if relevant, it can be claimed each year your company meets the qualification criteria
- Non-competitive - if your company meets the requirements, you will receive the funding
- Affordable - consultant/adviser fees can be covered by the additional funding received (a claim should not be made unless there is confidence that your company meets the requirements)
- Unrestrictive - it is not a loan to pay back (no future cash commitment or interest), you do not have to give up any control in your company to receive cash funds to invest, it is not as onerous as a grant application/monitoring and reporting requirements.
Think you have an R&D claim?
Understanding the nuances of tax legislation when it comes to R&D tax relief can be hard. If you hit a road bump in preparations, get in touch.
If you’d like to discuss a potential R&D project, book a call to explore your eligibility and start your tax claim journey.
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