R&D tax relief: possible pitfalls and top tips

Research and Development (R&D) tax relief was initially introduced by the government in 2000 with the aim of encouraging greater spending on R&D and increasing investment in innovation.

There are two schemes for claiming relief; the Small or Medium-sized Enterprise (“SME”) scheme and the Research and Development Expenditure Credits (“RDEC”) scheme. Relief can either reduce a company’s tax liability or loss-making companies can choose to receive a cash payment.

The SME scheme is significantly more generous than the RDEC scheme. If opting for a cash payment, the benefit under the SME scheme is approximately 33% of the qualifying expenditure, however under the RDEC scheme this would only result in approximately a 10% benefit. To put this into perspective, if a company spends £100,000 of qualifying expenditure under the SME scheme, they would receive a cash repayment of £33,350, but under RDEC the repayment would be £9,720.

The R&D pitfalls

Here at Chiene + Tait, our team of full-time R&D specialists work with many different sized companies across various industries. When speaking to companies who are considering making R&D claims, we have come across many who fit the size criteria of an SME but are not aware of other factors that can prevent them from claiming the more generous rate of relief. As this can have a significant impact on the amount of benefit a company can receive, at a stage when funding is vital to the success of a business, I have summarised some of the main factors below.

Grant funding and subsidies

There is a common misconception that if a company has received grant funding, then they cannot claim R&D relief. This is not true. However, receiving grants can impact upon the level of relief the company is entitled to claim, causing some or all of the qualifying project expenditure to be claimed under the RDEC scheme, potentially for the entire life of the project.

Because many companies rely on grant funding during the start-up phase, they often describe their entire business model in their grant application in attempt to secure the funding. The grant application is used to determine which of the company’s activities are subsidised, so if the entire business model is described, all projects could be impacted by the grant. This can have a significant impact on the benefit of an R&D claim. Therefore, it is important to keep this in mind when applying for grants and weigh up the potential benefit of an R&D claim vs the grant amount.

Contracts with customers

If a project is considered to be subcontracted into the claimant company, relief is only eligible under the RDEC scheme. Two of the main factors that need to be considered are whether the company retains the right to benefit from the IP generated and whether the company bears economic risk.

If a contract is in place that states the claimant company does not retain the right to benefit from the IP generated and they do not bear economic risk then the project is considered subcontracted for R&D purposes. The party who contracted the work into the Company needs to be considered, as this may mean the project is also ineligible for relief under the RDEC scheme.

Investments

A claimant company is required to include the accounting data of other entities if they are considered to be ‘linked’ or ‘partner’ enterprises. Aggregating this data can sometimes cause a company to breach the SME thresholds for R&D purposes.

A linked enterprise is an enterprise that can control another enterprise, or is controlled by another enterprise, either directly or indirectly. A partner enterprise is one that is not linked, but where an enterprise holds 25% or more of the capital or voting rights in the other (either on its own or in combination with other linked enterprises).

This is something that should be considered when carrying out an investment round.

The R&D tips

The total amount of R&D support paid out has increased annually, but HMRC still believe that many companies are missing out on relief, either because they are not aware they qualify, or because they are underclaiming. I have included some useful tips below, to help companies maximise their claim and ensure they are claiming the relief to which they are entitled.

Dividends

It is common for directors to take dividends, rather than putting themselves on the payroll, to avoid paying money through the PAYE scheme that could otherwise be invested back into the business. However, dividends are not a qualifying cost for R&D tax relief purposes and, as such, cannot be included in a claim.

As employees’ and directors’ gross salaries are a qualifying cost, it may be worth considering adding any directors to the payroll and paying them below the personal allowance and national insurance thresholds, so no PAYE or NIC are payable, and pay any further remuneration as dividends.

Staff

In the early stages of business, many companies will outsource work to specialists or utilise subcontractors and agency workers. Although this is sometimes the only option for a business, it is worth keeping in mind that you are more likely to get a bigger return on your investment if it is spent on employing staff, rather than engaging with third parties. This is because, for SME claims, costs spent on engaging with subcontractors and agency workers will be restricted to 65%. Further, if you are claiming under the RDEC scheme, there are multiple restrictions on third party costs, meaning you may not be able to claim any of these costs incurred.

Another important point to note when considering whether to employ staff is the staff expenditure limit. Currently, under the RDEC scheme, the payment of a cash credit is subject to a cap of the total PAYE and NIC paid to HMRC on behalf of the employees included in the claim. So, if you don’t have any employees involved in the R&D, you will not be entitled to a cash payment. The Treasury announced in the 2018 budget that a similar cap will be introduced for the SME scheme from April 2020 to prevent abuse of the relief by fraudulent companies. The cap will be three times the company’s total PAYE and NIC liabilities for the year of the claim.

Record keeping

Although HMRC do not require claimant companies to keep detailed records, it can help to maximise an R&D claim and to defend the quantum of the claim in the event of a challenge from HMRC. Clear descriptions on accounting entries and ensuring they are posted to a relevant nominal code make it easy to identify any qualifying costs related to the R&D activities. Cloud accountancy packages such as Xero, FreeAgent and Quickbooks make this increasingly easy, even allowing you to attach invoices to individual transactions.

Here at Chiene + Tait, our R&D specialists have years of experience preparing and submitting successful claims for hundreds of companies, across both schemes, in multiple industries. We are experienced in dealing with all of the factors mentioned above.

If you are considering claiming relief and would like to hear how we can help you, please email me at Eilidh.Hobbs@chiene.co.uk.