R&D Tax Credits Explained

A Complete Guide to R&D Tax Credit Claims

Below is a comprehensive guide to claiming R&D Tax Credits. It includes the eligibility criteria for the scheme, the types of activities that qualify, how to calculate your claim and more. This guide will be useful to any company that is considering claiming R&D Tax Credits or wants to optimise its future claims.

Introduction

The R&D tax credit scheme is a UK government scheme that is aimed at rewarding and incentivising innovation in the private sector.

Companies can file an R&D claim annually and it includes the costs for the qualifying R&D activities that the company carried out in that financial year (more on this later).

In general terms, the value of an R&D tax credit claim is dependent on expenditure – how much the claimant company has spent on activities that are considered R&D for tax purposes. There a few scenarios that affect how the claim value is calculated and we explore these in more detail below. To skip ahead to the calculation section of this page, click here.

If the claiming company is profitable, the R&D costs can be used to reduce the company’s tax bill to a far higher degree than the usual deductions. If the company is loss-making (i.e. if it does not owe any tax for that year), the claim benefit can either take the form of additional losses that can be carried forward to future years, or the losses can be surrendered for an immediate cash benefit.

Who Is Eligible to Claim R&D Tax Credits?

In order to make an R&D claim, a company must first be subject to UK Corporation Tax. This typically means that it is registered in the UK as an LTD or PLC but additionally, if a branch of an overseas company has a UK presence and is also subject to UK Corporation Tax, then it can also benefit from the scheme.

The eligible R&D work does not necessarily need to take place in the UK. However, the work in question does need to be funded (at least in part) by the UK-registered company. An example of this is a UK company that subcontracts some of its operations to a company that is based overseas.

The legislation that governs what activities can be included in an R&D claim is based around two main conditions:

1. Technological Advance

This means that the activity or project in question should theoretically add to the pool of technical knowledge that is currently available in that industry. We say ‘theoretically’ because the company activity and related IP are not actually released to the public during the claim process.

In practice, as well as gaining new knowledge, a technological advance may be achieved by developing something new or appreciably improving something that is already known. This could be the creation or improvement of a product, process or method. There is a misconception that the R&D tax credit scheme is only relevant to science-based sectors. This is simply not the case as eligible R&D work can take place in any sector, providing the criteria are met.

Also, it is the processes involved in the work that count towards eligibility rather than the end-result. For example, if a company creates something that looks identical to an existing product on the market, but it used a new or improved method to make it, it would still be able to claim through the scheme.

2. Resolution of Technological Uncertainty

The definition of technological uncertainty is where a solution to a technological problem is not either publicly available or readily deducible to a competent professional. In other words, the solution can’t be in the public domain and can’t be obvious. If others have achieved the same thing but it’s a trade secret or you have a unique environment, then your work can still qualify.

Therefore, in order for a project or activity to qualify, it can either be unclear whether the project’s technology goals can be achieved or how to achieve them in practice. This implies that the project presents a challenge that falls outside of the sector’s norms and there is a certain level of technical risk that exists in terms of the project’s viability at the outset. The project does not necessarily need to be a success by any measure to qualify. Again, it is the process that is looked at rather than the end result.

R&D tax credits eligibility

Examples of Eligible Activities

While you can claim in any sector and there are countless ways in which a company can qualify, we have compiled a brief list to give you a general sense of the activity-types that would typically qualify:

Manufacturing

  • Prototyping a new design
  • Materials testing
  • Making appreciable improvements to an existing product
  • Making adjustments to give a product new features or properties
  • Optimising a manufacturing process

For more information visit our R&D tax credits for manufacturing page

Software Development

  • Using untested development methodologies or architectures
  • Connecting various systems that are not typically integrated with each other
  • Addressing challenging scalability or security issues
  • Creating new machine learning algorithms
  • Developing software that processes large amounts of data
  • Developing firmware
  • Extending the functionality of existing systems such as CRMs

For more information visit our R&D tax credits for software development page.

Architecture and Construction

  • Designing or building non-typical structures
  • Design, with special considerations to thermal performance
  • Retrofitting buildings with safety features to comply with new regulations
  • Designing in difficult or non-typical sites
  • Designing with special considerations to energy consumption, water conservation, emissions and other environmental concerns

To learn more, visit our R&D tax credits for architecture page.

Engineering

  • Projects relating to aerospace or avionics
  • Non-typical projects in civil engineering
  • Petroleum, Oil & Gas Engineering
  • Hydrology Engineering
  • Materials engineering
  • And others

To learn more, visit our R&D tax credits for engineering page

For other general indicators of eligibility, click here.

Figure 2: The amount of R&D benefit claimed in 2016-2017, by industry sector

Costs that can be included in an R&D Tax Credit Claim

The following costs can be included in a claim when they are incurred on directly resolving technological uncertainty on a qualifying project:

  • Salaries of full-time or part-time staff members
  • Subcontractor costs
  • Contract Workers
  • Consumables (e.g: water, gas, electricity, cost of prototypes not for sale)
  • Software License costs

Costs that cannot be included in an R&D Tax Credit claim

Anything not on the list above, e.g.

  • Normal operational costs (e.g. web hosting, office space rental, food and travel expenses etc.)
  • Pay-outs of dividends to shareholders
  • Recruitment costs, referral costs, even of R&D staff
  • Costs of staff who are not directly and actively engaged in the R&D
  • Costs of R&D staff where their time is not directly contributing to the resolution of technological uncertainty
  • Costs of items that are used in production

How to Calculate an R&D Tax Credit Claim

There are two main types of R&D claims and each are calculated differently: If you have less than 500 employees and have a turnover of under £175,000,000 you would typically claim under the more lucrative SME Scheme. If you don’t meet both of the above conditions, you would typically claim under the RDEC scheme.

Below are the various examples of how a claim value is calculated:

  1. SME Scheme calculation for a company that was profitable and spent £100,000 on qualifying R&D activities in a given year:
  • £100,000 x 130% (enhanced rate) = £130,000
  • £130,000 x 19% (corporation tax rate) = £24,700
  • Claim value: £24,700
  1. SME Scheme calculation for a company that was loss-making and spent £100,000 on qualifying R&D activities in a given year:
    • £100,000 x 130% (enhanced rate) = £130,000
    • £130,000 + £65,000 = £195,000 (enhanced expenditure)
    • £195,000 x 14.5% (surrender rate) = £28,275
    • Claim value: £28,275
  2. RDEC Scheme calculation that was either profit or loss making and spent £1,000,000 on qualifying R&D activities in a given year:
    • £1,000,000 x 12% = £120,000 (above the line credit)
    • £120,000 – 19% (corporation tax rate) = £97,200
    • Claim value: £97,200

There are further factors that can affect how a value of a claim is calculated. For example, if your company’s R&D is subcontracted to another company, you would only be able to include 65% of the subcontracted R&D costs. For more information on this, click here.

Find out your claim value by using our R&D tax credit calculator

The R&D Claims Process

Companies typically submit their R&D claim at the end of their accounting period, when they submit their corporation tax return.

They can submit a claim for projects that they carried out within the previous two years from the time of submission. The R&D benefit is permanently lost for activities carried out earlier than that so if you think that your company has eligible costs in the previous two years, let us know.

A company that is looking to make an R&D claim must choose between delegating the process to their in-house finance teams, external accountants or R&D tax specialists. There are pros and cons to each of these approaches and we have explored this in more detail here.

The claims process typically consists of the following actions:

  • Assessment and confirmation of eligibility
  • Collection of technical and financial information relating to eligible projects. E.G. time-sheets, payslips, invoice summaries, project plans etc.
  • Separation of time and costs of eligible and non-eligible activities within a project.
  • If relevant, review of contracts between company and subcontractors that helped to carry out the R&D to ensure that all contracts are in compliance with the scheme
  • Writing the claim narrative and preparation of claim documentation
  • Review of claim and submission of claim pack

A successful R&D claim is usually paid out within 28 days of submission unless the case load of inspectors is particularly high or if the claim is queried or rejected.

Claim Enquiries and Disputes

It’s worth noting that when companies don’t follow best practices during preparation of an R&D claim of if they include something that breaches the legislative rules governing the scheme, this may trigger an HMRC enquiry.

An enquiry can range in severity from HMRC simply asking for additional information relating to a certain part of the claim, to them rejecting the claim outright.

In the worst case, they can even issue a penalty for R&D funds that the company had claimed in previous years if they conclude that similar breaches were made in previous claims.

To find out more about how to avoid an HMRC enquiry, click here.

To learn more about best practices in data collection for R&D claims, click here.

Additional Facts and Figures*

  • The average value of a claim in the SME and RDEC schemes is £53,876 and £272,881 respectively.
  • According to the latest available figures, UK companies claimed a total of £3.5 billion in the year 2016-17, through the R&D tax credit scheme. This is a 25% increase from the previous year.
  • The number of claims in the year 2015-16 rose by 22% from the previous year to 43,040. (the metric for 2016-17 and subsequent years is not available yet).
  • Surprisingly, it is projected that the number of R&D claims that were filed in 2016-2017 will actually see a slight decline in comparison to the previous year. This is despite a consensus in the industry that many sectors are under-claiming and not nearing their potential for utilising the scheme.
  • The 3 UK regions that claimed the highest benefit from the scheme in 2015-16 were London (£1.14 billion), South East (£680 million) and East of England (£395 million)
  • The 3 sectors that claimed the highest benefit from the scheme in 2015-16 were Manufacturing (£1,060 billion), Professional, Scientific and Technical (£800 million) and Information and Communication (£600 million)

*Sources: gov.uk and thehrdirector.com

Conclusion

Although the R&D tax credit scheme remains an excellent way for companies to offset the expense of innovative activities, many companies miss out on significant annual claims each year due to a lack of awareness of the scheme or misconceptions about it.

This is particularly true for certain sectors. For example, in the year 2016-17 construction firms made a total of only 1,365 R&D claims despite there being an estimated 314,590 construction-based businesses in the UK.

Figure 3: The number of R&D claims filed, by year

Number of R&D claims filed, by year

If you would like to find out whether your own company is eligible to claim R&D tax credits or you would like more information about the scheme, we would be glad to help.

At the minimum we would be able to give you a definitive answer about your eligibility and give you an accurate idea of the potential value of your claim at no obligation to you.