R&D Tax Credits will be significantly affected by the 2015 Summer Budget. Although the R&D Tax Relief scheme has benefited in recent years from a steady increase in rates, both for the SME scheme and through the introduction of the R&D Expenditure Credit (RDEC) or Above-the-Line system for large companies, the headline rate will be somewhat eroded by the announced reduction in Corporation Tax rates.
In simple terms, the less tax that is paid, the less beneficial is a relief that lets you pay less tax. Therefore, profitable companies, who are using R&D Tax Relief to offset the amount of tax paid, will see the bottom-line benefit fall accordingly.
Loss-making SME companies will not be affected, if they are receiving a payable cash credit but the relative benefit compared to carrying forward the enhanced losses will be reduced.
This is because at today’s rates, a company spending £100 on Research and Development (R&D) can claim an additional deduction to enhance that by an additional 130% so they are able to treat it as £230 actually spent in their Profit & Loss account. If they are loss-making in the year of the claim, they have a choice – they can either surrender the entire £230 at a rate of 14.5% giving a bottom-line benefit of 33.35% of the amount spent on R&D. Note that the first £100 that would normally be deducted as part of the normal P&L calculations is also surrendered. However, the other option is the company carries forward that enhanced loss for use against future profit, and saves the corporation tax.
With the current tax rate of 20%, the additional £130 of losses, on a like-for-like comparison with surrendering the enhanced loss, is worth 26% of the original amount spent, plus of course there is the usual 100% deduction for the original expenditure, which at a 20% tax rate is effectively worth 20% of the amount spent. This is clearest if you assume the company makes a profit of £230 in the subsequent year after claiming. If it had surrendered it’s enhanced R&D loss in the first year, it pays £46 tax, taking the net payments over 2 years to £-12.65, while if it had carried forward the loss, over 2 years the company would be on 0.
The announcements in the Emergency Budget 2015 that reduce corporation tax to 19% in 2017 and to 18% in 2020 therefore erode the value of carrying forward the relief.
In the example above, in 2017 the tax payable with a £230 profit in year two would be only £43.70 dropping to £41.40 in 2020, had it surrendered the losses while the £33.35 had the losses been surrendered would remain, reducing the differential between the two options to £10.05 in 2017 and £7.75 in 2020.
Similarly, profitable SMEs, who use the enhanced R&D losses to offset against current tax see the value reduced, from 26% currently to 24.7% in 2017 and 23.4% in 2020.
RDEC, because it is applied ‘Above the Line’ becomes more valuable. Currently it is given at 11% before tax. The 20% tax rate means that the bottom-line benefit is 8.8%. The reduction in corporation tax rates increases this to 8.91% in 2017 and 9.02% in 2020.
The current Large company scheme will be phased out by the time the new corporation tax rates apply and will therefore be unaffected.
For the full R&D Rate table see here
From 1 August 2015 universities and charities are prevented from claiming R & D expenditure credit on their own research or when working as a contractor.
Other changes from 1 April 2015
There are two main scenarios to consider:
1) Manufacturing trials
Where an R&D project includes production or manufacturing trials in order to test the advance made it is not uncommon for the results or waste materials to be sold on. Prior to April 2015 was that, provided the trial was a genuine R&D trial, up to the point at which the scientific or technological uncertainties had been resolved, materials necessary for the trial runs would be eligible for relief as consumables costs. With the changes introduced, any materials that form part of an item, which is then sold on, would not be eligible for relief.
Not only is this change going to reduce certain claims, it is also going to introduce a potential additional record keeping burden on manufacturing companies so that eligible and ineligible costs can be identified for the purposes of the claim.
HMRC has confirmed that it is not the intention for this new legislation to catch the scenario where waste materials are sold for scrap or at a significantly reduced price.
2) First in class prototype
This refers to situations where it is not feasible to produce a prototype for testing, usually because the item being built is too large, complex and expensive, such as a plant, or battleship. Previously, in building a first in class prototype, companies were able to identify certain materials costs that required the resolution of technological uncertainty and include these in their R&D claim despite them also being incorporated in the end item, which is then sold to a customer. These costs will now also cease to be eligible from 1st April 2015.
These two scenarios have been the subject of a great deal of debate between claimants, advisors and HMRC over many years. Our view is that this change is a move by the Government to draw a line under any uncertainty or grey area, whilst also funding the two rate increases, which will benefit a great number of claimants. The measure will put a significant dent in a minority of very large R&D claims; however there will also be a huge number of claimants who will be completely untouched by the change.