As part of a Government drive to encourage innovation, UK based companies may be eligible for tax relief if they are involved in Research and Development (R&D). The government is committed to encouraging more small and medium sized (SME) companies to claim R&D tax relief.
R&D tax relief can only be claimed by companies that have incurred expenditure on qualifying R&D projects that are relevant to the company’s trade. A project should address an area of scientific or technological uncertainty and be innovative. The innovation needs to be an improvement in the overall knowledge in the relevant field of research, not just an advancement for the company. An important point to appreciate is that the activity does not have to create something completely new from scratch.
Companies who have not applied for R&D tax relief before, with turnover £2m or less and with less than 50 employees can apply to HM Revenue & Customs (HMRC) for “Advance Assurance” before their first R&D claim. HMRC will consider the R&D project and then give assurance that they will allow the claim without further enquiries for the first three accounting periods. Companies can still apply for R&D without Advance Assurance, it is there simply to give proof that your company will get R&D tax relief.
Tax relief available to SME companies
SME companies can claim “enhanced deductions” against its taxable profits for expenditure which is qualifying R&D expenditure. The amount of the enhanced deduction is currently 130%. This is in addition to the actual expenditure, giving a total deduction of 230%. If the R&D claim creates a tax loss, then the company may be able to surrender the loss for a cash repayment of 14.5%. An alternative scheme, R&D Expenditure Credit (RDEC), is available to large companies but is not detailed in this article.
To illustrate the above, if a company has turnover of £700,000 and allowable costs of £400,000, its profits chargeable to corporation tax will be £300,000. At a corporation tax rate of 19%, this will be a tax liability of £57,000. If £100,000 of the £400,000 allowable costs were qualifying R&D expenditure, then the enhanced deduction would be £130,000 (£100,000 x 130%). The enhanced deduction of £130,000 is then deducted from the £300,000 profit when working out the corporation tax liability. This then gives an adjusted profit of £170,000 which at 19% is a tax liability of £32,300. Meaning a corporation tax saving of £24,700.
If a company has turnover of £450,000 and costs of £400,000, its profits chargeable to corporation tax will be £50,000. At 19% corporation tax this will be a tax liability of £9,500. If £100,000 of the £400,000 costs were qualifying R&D expenditure, then the enhanced deduction would, again, be £130,000 (£100,000 x 130%). The enhanced deduction of £130,000 is then deducted from the £50,000 profit when working out the corporation tax. Deducting the £130,000 from the original profit of £50,000 gives an adjusted loss of £80,000. This loss can be surrendered for a cash repayment at 14.5%, in this situation £11,600. Meaning, overall, the company is better off by £21,100.
If a company has already made a loss before the enhanced deduction, then the company can surrender the R&D expenditure and the enhanced deduction for a cash repayment. So, with a £100,000 R&D spend, this would be the £100,000 plus the £130,000 giving a total amount surrendered of £230,000. At 14.5% this would give the company a cash repayment of £33,350.
Using the R&D expenditure and enhanced deduction against profits will give a saving at the rate of corporation tax (currently 19%). This is, obviously, better than surrendering for a cash repayment of 14.5%. However, if there are no profits to utilise the R&D against, receiving a cash repayment will help the company financially.
Help with R&D
If you think you may qualify for R&D and would like to talk to us more about it, please do not hesitate to contact your local MFW office to discuss this further.