UK R & D Tax Credits

Although the UK Research and Development (R&D) Tax Credit Scheme has been available for SMEs since 2000 and for large companies since 2002, the various adjustments to the scheme that were made last year has meant that for some companies the value of the relief will have more than doubled from 7.5 per cent at the beginning of 2008 to as much as 21 per cent today. There are similar schemes in other countries but this article focuses on the UK.

Here is a quick R&D claim checklist:

- Do you employ scientists, engineers, software developers or technicians?
- Have you developed a new product?
- Have you appreciably improved an existing product?
- Have you improved an existing manufacturing process?
- Have you conducted in-house R&D?
- Have you developed software in-house?
- Are you a Small or Medium-sized Enterprise (SME) that has subcontracted out any of the above?
If the answer to any of these questions is ‘yes’, then you could be eligible to claim R&D tax relief.

Additionally, as the R&D scheme has matured there has been increasing clarity in the industry and within HMRC as to the type of activities that will or will not qualify.

There may be many companies who have considered the R&D scheme in previous years and either made the decision not to claim in the belief that the benefit was not sufficiently worthwhile or because they were not entirely sure if their activities met the tax definition of R&D. In the current economic climate any company developing new or improved software or products should look again at this relief.

In many cases both of these assumptions may require revisiting and in the current economic climate, claiming R&D tax relief is a relatively easy way for companies to reduce their cost base and increase liquidity, and we provide here a number of points for companies to reconsider whether they can make use of this valuable relief. Even if your company performs no R&D directly, it may still be able to utilise the scheme as part of commercial negotiations.

Revisiting your R&D capability
The 2004 DTI Guidelines on R&D provide a definition of R&D for tax purposes. This is far removed from the perception that many people still hold about what qualifies as R&D and is in fact much broader than the traditional view of R&D being something that only happens in a laboratory full of scientists. While there is no substitute for reading the guidelines in detail, in summary, to qualify for the scheme requires projects that seek a technological advance through the resolution of technological uncertainty.

What this means in layman’s terms is that the staff in your company need to be trying to achieve something clever (the ‘advance’) by solving problems (‘the uncertainty’) in a field of science or technology.

These fields of science and technology may range from biotech and pharmaceutical new drug development to software development in banks, systems integration in aerospace and engineering and improving manufacturing processes. A claim potentially can include both in-house activities and solutions or consulting work for other parties.

One of the other reasons why companies may have chosen not to claim in the past, or under-claimed, is because of the belief that an R&D claim can only encompass the two or three ‘problem-solvers’ on an R&D project. What many companies do not realize is that the legislation provides that all activities that directly contribute towards resolving the technological uncertainty can be claimed for.

In many R&D projects, the vast majority of the development aspects happen outside the R&D department, as often the solutions proposed by the core R&D staff cannot be validated without trying to implement them in a production environment.

By way of example, in manufacturing claims there is usually a large amount of ‘blue-collar R&D’ that occurs on the shop floor; in software claims a large amount of R&D will occur during beta-testing once a working system is being used with real-world customers and in systems integration work will qualify that under normal circumstances would be considered as routine but without which the R&D cannot be validated.

What’s changed?
There were a number of changes to both the large companies’ scheme and the SME scheme in 2008.

Large Companies: On 1 April 2008, the rate of R&D tax relief for large companies was increased from 125 per cent to 130 per cent. At the same time, corporation tax was
reduced from 30 per cent to 28 per cent. This resulted in a change to the net benefit of the tax relief from 7.5 per cent to 8.4 per cent.

SMEs: A number of changes were introduced in 2008.

1. From 1 August 2008, companies with between 250 and 500 employees are now able to claim under the highervalue SME scheme, which includes surrender of losses for a cash credit. These companies will be the main beneficiaries of the legislative changes, with their claim benefit increasing from 8.4 per cent under the large company scheme to under the SME scheme, either 15.75 per cent to a 21 per cent taxpayer or as a 21 per cent benefit to a 28 per cent taxpayer.

2. At the same time, the enhanced deduction rate of R&D tax relief for SMEs was raised from 150 per cent to 175 per cent. In combination with the smaller companies corporation tax rate rise to 21 per cent in April 2008 this has significantly increased the value of this benefit.

3. The percentage of surrenderable qualifying losses to receive a cash credit was reduced from 16 per cent to 14 per cent resulting in a net benefit of 24.5 per cent of the
uplifted amount.

4. A going concern rule was introduced, such that a company is required to have drawn up its latest accounts on a ‘going concern basis’ and provided that nothing in the accounts indicates that they were only prepared on that basis because of an expectation of receiving R&D tax relief (or VRR (Vaccine Research Relief)).

5. The cost of clinical trials as an allowable category of expenditure was introduced.

6. A cap of €7.5 million was introduced on the total amount of SME R&D and VRR aid a company can receive in respect of a particular R&D project in respect of expenditure incurred on or after 1 August 2008. However, it should be noted that if it looks as though
this cap is likely to be reached, it may be effective and commercially justifiable to have a series of smaller projects instead.

And don’t forget Research and Development Allowances (RDAs)

These are available for capital expenditure on R&D - or facilities for providing R&D - and provide an immediate 100 per cent deduction. While the definition of R&D is the same as for the enhanced relief scheme, the range of costs is broader for these (for example, large companies can claim for R&D projects they subcontract out, as well as indirect supporting activities) and they may provide a useful benefit.

Taking commercial advantage of the R&D scheme

Finally, whether or not your company’s activities qualify as R&D, there are still a number of areas where the relief can be valuable as a negotiation tool and a number of ideas
based on this are included below.

- If you are a large company and are subcontracting R&D out to another large company, there will be 8.4 per cent benefit to them. This may be a useful negotiation point at
the outset of the contract.

- Conversely, if you are a large company bidding for work that will qualify under the R&D scheme you know that you will have effectively an 8.4 per cent reduction in your cost base. In a competitive bidding situation it may be advantageous to either offer a proportion of this back to the client as a ‘sweetener’ or to use it to undercut the
competition.

- If you are an SME that has had R&D work subcontracted to you by another SME, the paying company can claim the enhanced deduction on the amounts they are paying you. In the event of the claimant being loss-making the enhanced deduction is surrenderable for a cash credit. However, as it is likely that the claimant will need your assistance in order to submit a claim this may be a useful negotiating point.

- If you are an SME subcontracting R&D work out to another SME company remember that there is a potential 175 per cent deduction on the expenditure which may be a useful cushion. However, ensure that your contractual arrangements include the support from
the company performing the R&D that you will need to prepare a robust claim to submit to HMRC.

Research and Development Tax Credit help
Consultancy and advice on claiming R&D Tax Relief