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.
- 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).