Research & development tax credits for small businesses

• Tim Fouracre
• Wednesday, 14 January 2009
• Tax
• research development tax tips

4,500 small businesses are claiming research and development tax credits each year according to an HMRC guide on R&D tax credits for small businesses.

Qualifying R&D expenditure helps reduce a company’s corporation tax bill but with such a small number of companies participating, either the scheme is unknown or there are not many innovative small companies in the UK.

Following is a brief overview of the R&D tax credit system. Ask your accountant for more details to see if your company can benefit.

R&D Tax Credit

Qualifying R&D expenditure reduces your profits chargeable to corporation tax and therefore reduces your corporation tax bill. Put simply, your company pays less tax.

What is R&D?

Expenditure that qualifies for R&D adheres to these <a href=”http://www.berr.gov.uk/dius/innovation/randd/randd-tax-credits/RandD-Tax-Guidelines/page14094.html”>general rules</a>:

• Developing scientific or technological knowledge that isn’t commonly available e.g. creating or appreciably improving a product, process or service.
• Being innovative in a commercial sense or new to you isn’t enough on its own.
• Scientific or technological challenges have been overcome as part of the work. If a solution is obvious to a competent professional then it is not R&D.
• Simply buying new technology and using it isn’t R&D, but adapting it or developing it for your own purposes might be if it involves scientific or technological advances.

Eligible R&D Costs

• Employing staff directly who are actively engaged in carrying out R&D.
• Paying a staff provider for staff provided to the company who are directly and actively engaged in carrying out R&D.
• Consumable or transformable materials used directly in carrying out R&D (broadly, physical materials which are consumed in the R&D).
• Power, water, fuel and computer software used directly in carrying out R&D.

Restrictions

• There must be qualifying expenditure of at least £10,000 on R&D in the accounting period in order for a claim to be made.
• If any IP arises from the R&D then it must vest in the company to be eligible as R&D.
• An SME is a company with fewer than 250 employees, and either annual turnover not exceeding €50M or a balance sheet totalling €43M, and which is not part of a larger enterprise that would fail these tests.

HMRC provide a useful flow chart to gauge whether expenditure is eligible for an R&D tax credit: R&D Tax Credit Flowchart.

R&D Tax Credit Example

Ordinarily, expenditure that is wholly and exclusively for business purposes is an allowable expense for corporation tax. For example, if you spend £50,000 on salaries then 100% of that salary cost (i.e. the full £50,000) is eligible to reduce profits chargeable to corporation tax.

Assume SME corporation tax is set at 21%. £50,000 normal expenditure effectively reduces a corporation tax bill by £50,000 * 21% = £10,500.

The R&D tax credit permits 175% (from 1 August 2008) of qualifying expenditure in SMEs to offset profits chargeable to corporation tax. If the salary cost referred to above qualified as R&D then £50,000 * 175% = £87,500 is eligible to reduce profits chargeable to corporation tax.

Assume SME corporation tax is set at 21%. £50,000 R&D expenditure reduces a tax bill by £87,500 * 21% = £18,375.

£50,000 expenditure qualifying as R&D saves an additional £7,875 in tax (£18,375 – £10,500).