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 general rules:

  • 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).

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Posted by Tim Fouracre

Tim founded Clear Books in 2008. Like many small business owners he worked from home for 15 months to get his startup off the ground. Today Tim enjoys helping Clear Books, its customers and its growing team innovate and achieve. Tim did his GCE O Levels in Ghana.