R&D tax: key points in the recent consultation

This post is part of our Entrepreneurial team’s regular series of blogs.

Research & Development Tax reliefs (R&D) play a key role in promoting UK investment by reducing the costs of innovation, so it’s unsurprising that the Government wants the reliefs to remain up-to-date, competitive and well-targeted.

A consultation on the future of R&D Tax relief recently closed, exploring how this is supported and whether changes may be appropriate. Below are some of my thoughts on the key points brought up.

The case for consolidating the two schemes into one

In some instances, the R&D Tax legislation can be overly complex. Having two schemes means having two overlapping sets of rules instead of a single coherent system. Simplifying and consolidating the schemes makes sense, provided SMEs continue to receive preferential rates.

The RDEC model provides a step-by-step methodology for the calculation, and it would therefore make sense for the SME scheme to mirror this by standardising the process. Ultimately this should help HMRC review the claims effectively, improving turnaround times.

R&D compliance

There have been growing concerns over the past few years that the system does not provide adequate controls for the allocation of tax credits. HMRC aim to process claims within 28 days. However, due to their sheer number, there isn’t a lot of time for them to consider every case in detail. Whilst HMRC have the power to enquire into claims after they have been “accepted”, we should look to develop the incentive so that it provides as much certainty as possible in the first instance. After all, getting it right first time should be good for everyone and improve consistency throughout the process.

The new CT600L form helps this to a certain degree, but new regulations are required. Currently, there is limited regulation covering who can provide advice and the supporting documentation required. R&D Tax can have a significant impact on a company’s tax position and strategy, so it’s important that companies get the right professional advice on the matter.

Comparatively, other business advisory professionals (such as accountants and lawyers) must rightly conform to regulation and governance from their respective industry bodies. There is no such body to regulate R&D specialists. New regulation in this area would help to improve consistency and ensure companies are not put at risk of making an illegitimate claim.

Qualifying expenditure and new R&D definition

The world is ever-changing and, as such, incentives should adapt accordingly. Modernising the ‘software costs’ category to accurately reflect how data and hosting costs contribute to R&D processes is welcomed, and I hopefully look forward to this being reflected in both updated legislation and guidance once the consultation is complete.

It is also good to see the Government considering whether the R&D definition needs updating. This is especially necessary in terms of clarity, or to widen the kinds of research covered by reliefs. The UK definition of R&D was set out last in 2004, therefore it is definitely due a revisit. There’s a particular opportunity to identify better ways to address R&D practices and fields, which have changed significantly since then.

Overall, change is definitely coming. However, I view it as a positive modernisation. Genuinely innovative companies shouldn’t be worried about change, as the ultimate goal is to update and target the reliefs, whilst helping attract and retain key businesses in the UK.

If you have any questions about R&D tax relief, get in touch with our team.

R&D tax and the impact of loans: what to look out for

In the past year we’ve seen a marked increase in the availability of loans for start-ups that focus on technical innovation. These provide favourable rates and have high acceptance levels, particularly for companies that are pre-revenue. There are also a number of “COVID loans” available, such as the Bounce Back Loan (BBL) and Coronavirus Business Interruption Loan Scheme (CBILS), which has provided some vital cash to keep the lights on during the pandemic.

In most instances, these favourably-termed loans are notified state aid, meaning that there are significant complexities with how they interact with R&D Tax relief. If the loan is deemed to be notified state aid, the same rules apply as if they had received a notified state aid grant. EU regulations require that a single project cannot receive more than one form of notified state aid meaning that, if it is determined that a project has been funded via a notified state aid loan, the project would be ineligible under the SME scheme.

Most of these loans are designed to support working capital commitments rather than specific R&D projects. However, we have seen companies inadvertently impact their R&D tax claim due to how they have allocated the loan. The devil is very much in the detail here and it is important to understand the terms of the loan agreement fully.

Firstly, you need to check to see whether the loan is indeed a notified state aid – something that the loan provider should be able to confirm. If it is, the activities and costs relating to the R&D project should be excluded from the loan application, protecting any tax benefit that would be available under the SME scheme. Instead, check the terms to see if the loan funds can be used for non-R&D expenditure such as marketing or rent, and keep records so that there’s an audit trail to show that there is no-cross over in funding.

Whilst these loans are on favourable terms, they still need to be repaid. It would foolish to restrict the ability to utilise all available relief due to lack of planning, particularly when most of these loans are designed to support the day-to-day running of a business rather than specific R&D projects. With a bit of tax planning it is possible to maximise the overall relief available and get the benefit of both.

If you need any support, or have any questions, contact us and we’ll help.

This post is part of our Entrepreneurial team’s regular series of blogs.

Identifying qualifying R&D in the field of software development

This post is part of our Entrepreneurial team’s regular series of blogs.

The number of Research and Development (R&D) Tax Relief claims made in the computer science and information technology industries has rapidly increased in recent years. With that, HMRC have invested time and resources into educating their inspectors to identify qualifying and non-qualifying activities within software development claims. This is because, although the Business Energy and Industrial Strategy (BEIS) guidelines (that define the qualifying criteria for R&D tax relief) apply equally to all fields of science and technology, HMRC recognised that there had been difficulties in the past in applying them to some software projects and therefore determining whether they were eligible for relief.

As well as training their staff internally, HMRC published guidance for claimant companies to assist them when preparing claims, to accurately capture only qualifying activities and costs. A summary of the key points are as follows:

Advancing knowledge or capability in the entire field

The advance or appreciable improvement being sought needs to advance the knowledge or capability across the whole field of computer sciences and information technology, rather than the company’s own knowledge or capability. Whether the advance applies to the entire industry or only the company can sometimes be hard to ascertain in a fast-moving industry such as computer sciences. This should be considered by a competent professional working in the field and by reference to publicly available information.

Focus on the underlying technology

The technological advance being sought should focus on the underlying technology being developed i.e. the algorithms and methodology, rather than the commercial output of the software. This is because software can be developed to provide functionality that is novel, however the methodology applied to achieve this is routine, and therefore non-qualifying.

How to identify technological uncertainties

As with all other industries, the claimant company must also face technological uncertainties when seeking to achieve the advance. Technological uncertainties arise when how to achieve the aim it is not readily deductible by a competent professional or by applying existing methodology. Examples of technological uncertainties that HMRC provide include:

  • Developing new or improved data architectures that cannot be achieved with readily deducible solutions, e.g. pushing beyond the boundaries of existing readily available database engines.
  • Extending software frameworks beyond their original design, where knowledge how to extend these was not available or readily deducible at the time.
  • System uncertainty when working with multiple components, resulting from the complexity of the entire system, rather than how the individual components behave, i.e. components cannot be assembled into an established pattern.

Separate the R&D project from the commercial project

R&D projects must be carefully defined within the larger commercial project. Any activities that do not attempt to overcome technological uncertainties do not qualify for relief and fall out-with the project for tax relief purposes. Specific activities that HMRC state do not qualify for R&D tax relief include:

  • Planning activities associated with non-R&D elements of the project such as financial, marketing and legal aspects.
  • Development of routine aspects of the software, such as the user interface, rather than the underlying technology.
  • Testing only qualifies if the purpose of the testing work is to feed back into the development, not to validate that it works properly once the technological uncertainties have been resolved.
  • Deployment or release activities that transfer software to production systems generally happen after the uncertainty is resolved and, as such, do not qualify.
  • Maintenance activities or minor fault fixing where no technological uncertainties arise do not qualify.

HMRC are increasing resources in their R&D team and diverting and re-training staff from other areas to enable them to process and accurately analyse the eligibility of claims. Therefore, it is important that companies consider and adhere to the above guidance when making software development claims.

Here at C+T we have extensive experience in preparing R&D claims in the computer sciences sector and our report to support a claim is designed to give HMRC all of the information it requires to assess its eligibility and prevent an enquiry being opened to request more details.

Our team of experts are on hand to help you through the claim process, give you peace of mind that all relevant factors have been considered, and significantly reduce the risk of an enquiry. If you have any questions, get in touch and we can advise.

If you would like further advice regarding the availability of Research & Development Tax Relief relief, please get in touch with us.

New draft legislation affecting R&D tax credit claims

HMRC has published draft legislation that introduces a PAYE/NIC cap on the payable tax credit available for R&D claims under the SME scheme.

A cap has been discussed for a number of years in order to help prevent abuse of the SME scheme and there is already a similar cap under the RDEC scheme.  There was, however, some worry that any new legislation would inadvertently impact genuine innovative businesses. Following extensive consultation, the draft legislation has been published with the following caveats.

  • A company making a small claim for payable credit below £20,000 will not be affected by the cap.
  • A company will be able to include related party PAYE and NIC liabilities attributable to the R&D project when calculating the cap, and these will be subject to the 300% multiplier.
  • A company’s claim, of any size, will be uncapped if it meets two tests. These tests require that a company’s employees are creating, preparing to create or actively managing intellectual property (IP) and that its expenditure on work subcontracted to, or externally provided workers provided by, a related party is less than 15% of its overall R&D expenditure.

The above changes are due to form part of the Finance Bill 2021, so will have effect for accounting periods beginning on or after 1 April 2021.

Dave Philp, Head of R&D Tax at Chiene + Tait, said: “Overall this is good news. There were worries that the initial draft would impact genuine claims rather than the rouge ones that are the target of this anti-avoidance measure.

“The changes made following the consultation should mitigate all impact on authentic claims.”

If you have any questions, please contact our R&D Tax team at rdtax@chiene.co.uk.

Business must prepare for R&D tax relief crackdown

In this blog, Dave Philp Head of R&D at Chiene + Tait outlines the implications of a potential clampdown on spurious research and development claims to HMRC.

R&D (Research and Development) Tax Relief, introduced in 2000 to encourage more company investment into innovation, is more popular than ever. In 2017-18, UK companies submitted over 48,000 claims for R&D tax credits. A total of £4.3bn in tax relief was secured, an increase of £1bn from the previous year. Here in Scotland, £175m in R&D tax relief was secured by businesses in 2017-18. While this rise in claims is positive, suggesting more UK businesses are focusing on innovation as a way to make themselves competitive, there are also concerns about illegitimate claims being submitted.

HMRC is now taking steps to combat fraudulent claims, reporting that it has already identified and prevented half a billion pounds of fraud linked to R&D tax credits. Last year the Government announced it would re-introduce the PAYE and NIC cap on SME payable credits, a move aimed at preventing fraud within structures set up to claim a tax credit despite there being no evidence of UK-based innovation activity or job creation.

Following the internal re-structuring of HMRC’s R&D tax teams last Autumn, it was also announced in the Queen’s speech that the Government would create a single, beefed-up, anti-tax evasion unit to cover all taxes and introduce new anti-avoidance measures. This potential forthcoming clampdown on R&D tax credit abuse in the UK follows a similar process carried out in Australia in 2018 which sent shockwaves through that country’s software sector. The Australian Government’s crackdown had significant impact with companies, including the tech firm Airtasker, being ordered to pay back millions of dollars they had received in R&D tax breaks.

While a number of businesses there were caught on the hop, the Australian Tax Office had made clear a year earlier of their intention to review R&D claims from software companies. This came amid concerns that advisory firms were encouraging companies to claim for work, which didn’t count as pure R&D. Despite the British Government getting set to impose greater scrutiny here, its support for R&D tax credits is unlikely to dissipate, especially with the UK having just completed its withdrawal of the EU.

Indeed, the new Boris Johnson-led administration has stated that it will review the definition of R&D, mainly to further incentivise cloud computing and data projects. It has also announced it will increase the R&D Expenditure Credit available for large companies and grant-funded projects. Potential abuse of R&D tax relief claims is, however, likely to be subject to much closer scrutiny going forward. To assist this process, one of the areas that the Government should be focused on is tougher regulation for those who advise companies on R&D tax relief.

Whilst there are a number of good, tax focused, R&D advisors operating within the UK, there are also a number of ‘experts’ who resort to cold-calling and wrongly advising that a company can easily qualify for relief. HMRC can take their time opening enquiries into a company’s tax affairs and any erroneous claim will be required to be repaid, along with potential penalties and interest. It will also likely be a red mark in any due diligence process, should it wish to be sold in future.

While other business advisory professionals, such as accountants and lawyers, must rightly conform to regulation and governance from their respective industry bodies, there is currently no such body to regulate R&D specialists. New regulation in this area would help to ensure companies are not put in risk at making an illegitimate claim.

Time will tell if the UK’s R&D tax credit crackdown will prove to be as harsh as what occurred in Australia.  There is, however, no doubt that companies need to consider whether they meet HMRC’s definitions as set out in the tax legislation and guidance with sufficient back up to support their claim. For those companies that are unsure of this process it is important they work with a credible and established adviser, ideally one that is currently governed by an industry code of conduct.

How (a background in) sport has helped me settle in at C+T

Playing sports has always played a huge role in my life, filling the majority of free time I have. I feel the experiences I have encountered through playing sport have allowed me to begin developing the skills necessary to be successful in my professional career. However, in order to develop my skills further, I needed real exposure to a professional environment which is where C+T comes in.

Going back to this time last year, summer 2018, I was about to take on one of the most exciting challenges, one that on paper seems very different to the challenge here at C+T, but surprisingly had many similarities.

Setting off on my own on the 18,000km+ journey to Christchurch, New Zealand to play rugby with one of the country’s most prestigious teams is something I had previously only dreamed of. The complete unknown loomed from my first step on NZ soil. Everything was new to me; the people, the culture and the environment in general were a huge change – the term ‘thrown into the deep end’ springs to mind!

You might be wondering what this has to do with an Entrepreneurial Tax Internship in Edinburgh? The feelings I faced on day 1 here at C+T were similar, albeit I wasn’t throwing myself around the office (most of the time). Entering a new, professional environment comes with the same feelings of uncertainty, which I have come to realise must be cherished and taken full advantage of. The opportunity to do something new and different allows you to develop and grow as an individual, both in the office, on the field and in life generally.

After somewhat settling into life here as an intern I have been exposed to a vast variety of taxes, tax reliefs and tax procedures from CGT to EMIs to completing corporation tax provisions. I cannot speak highly enough of the patience and understanding I have had from everyone thus far; I assume that an intern asking questions every five minutes can be a bit irritating (to say the least!), but if you don’t ask, how do you ever learn?

I have thoroughly enjoyed being exposed to the R&D team at C+T, learning about legislation regarding tax relief has allowed me to understand the substantial impact that correct R&D advice can have on a business. Listening in on calls and seeing first-hand the interactions between clients showcased the friendly, but professional manner that C+T hold themselves to. Working with the R&D department, I got the chance to learn and understand the new and unique technological advancements each client makes, something I found to be a fascinating!

One final thing that stands out for me about C+T are the people. They say the people make the firm and I believe that to be true here at C+T. Like the Kiwis, I received a warm welcome, they really made me feel like part of the team from day 1, showing me that C+T put an emphasis on developing relationships both internally and externally.

Overall, I am looking forward to furthering my knowledge and developing my skills in my final two weeks at C+T and I am excited for any future challenges that may arise both in the office and the field.

Grants v R&D tax credits – How to have your cake and eat it too!

In this blog David Philp in our Entrepreneurial Tax Team highlights how receiving grants can restrict a company’s ability to claim other tax reliefs such as R&D tax credits.

 

Grants form a vital part in the startup lifecycle, providing critical financial support to innovative companies. They give companies cash at a time when they are unlikely to have profits or even an income stream. The cash can be used to invest in further development, or to just keep the lights on for another couple of months.

However, as the saying goes “you don’t get anything for free” – receiving a grant could restrict the company’s ability to claim further tax reliefs and incentives.

Research & Development (R&D) Tax Relief (further info can be found here) is one of the most generous corporation tax breaks available, designed to encourage innovation and increase spending on R&D activities. It provides vital funds to startups in the early years of their development. There are two R&D schemes that run in parallel: the SME scheme and the RDEC scheme.

To qualify for the SME scheme, the company must have fewer than 500 employees and either have an annual turnover of less than €100m or gross assets of less than €86m. The SME scheme is by far the more beneficial out of the two available. For every £1 the company spends on qualifying R&D costs, the company can receive 33.35p in tax credits. This is a significantly higher level of relief than the level available under the RDEC scheme, which provides an 8.8p (which for expenditure after 31/3/17, increases to a whopping 8.9p) tax credit for every £1 spent on qualifying R&D costs (there are also further restrictions on what expenditure qualifies under the RDEC scheme).

The main issue that arises is that, as the SME scheme is so advantageous, the relief itself is deemed to be Notified State Aid. A Notified State Aid is one where the European Commission has been notified of the grant’s existence. In a bid to guarantee a level playing field for European businesses, the European Commission restricts Notified State Aids to one per project. That means if the company has already received Notified State Aid for a project, that project will not qualify under the SME scheme.

Unfortunately, it is not possible to repay the Notified State Aid. Once received, the project is automatically excluded from claiming R&D tax relief under the SME scheme.

This can have a disastrous effect to the availability of future relief for the company, which is best shown by the example below. Let’s assume that a loss-making fintech company (SME) is developing a single R&D project, spending £250,000 on R&D-qualifying staff costs and £70,000 on costs which were subcontracted to another company. To help with cashflow they also applied for a grant of £40,000.

Option A Option B
No Grant Received £40,000 Notified State Aid Received
Loss Making
SME RDEC
Qualifying Costs
Staff costs 250,000 250,000
Subcontractor costs (SME – restricted to 65%, RDEC Scheme – ineligble) 45,000 0
Less: Grant received (ineligible under SME Scheme, instead eligible under the RDEC scheme) 0 0
Qualifying costs under the SME scheme 295,500 0
Qualifying costs under the RDEC scheme 0 250,000
Tax Relief
SME scheme – tax credit worth 33.35% of qualifying costs 98,549 0
RDEC scheme – tax credit worth 8.8% of qualifying costs (subject to restrictions) 0 22,000
Grant received 0 40,000
                                                                                                        
Total relief (R&D and Grant) 98,549 62,000

 

You can see that, if the grant was Notified State Aid, it would significantly restrict the total relief available to the company. In this instance, the company would have been in a better position had it not taken the “free money”. This also restricts relief for future periods. Therefore, it is imperative to consider all your options before accepting cash in a form of a grant.

There are, however, a couple of things that you can do to avoid any potential pitfalls. By following the tips below it is possible to maximise your claim by combining both grants and R&D tax relief:

Know what type of grant your applying for – firstly, not all grants are classed as Notified State Aid and, as such, not all grants will land you in the less advantageous RDEC scheme. De-Minimis aid, which can distribute up to €200,000 worth of funding, is not classed as Notified State Aid and will therefore not force the project into the RDEC scheme. In this instance, it is possible to split relief over the two schemes: subsidised expenditure would fall under the RDEC scheme while the remaining unfunded expenditure will remain qualifying under the SME scheme, as seen in Option C below.

 

Option A Option B Option C
No Grant Received £40,000 Notified State Aid Received £40,000 De-Minimis Aid Received
Loss making
SME RDEC SME/ RDEC
Qualifying Costs
Staff Costs 250,000 250,000 250,000
Subcontractor costs (SME – restricted to 65%, RDEC Scheme – ineligible 45,500 0 45,500
Less: Grant received (ineligble under SME Scheme, instead eligible under the RDEC scheme)                              0                                                      0                                          -40,000
Qualifying costs under the SME scheme 295,500 0 255,500
Qualifying costs under the RDEC scheme 0 250,000 40,000
Tax Relief
SME scheme – tax credit worth 33.35% of qualifying costs 98,549 0 85,209
RDEC scheme – tax credit worth 8.8% of qualifying costs (subject to restrictions) 0 22,000 3,520
Grant received 0 40,000 40,000
                                                                                                                                                  
Total relief (R&D and Grant) 98,549 62,000 128,729

 

Determine what project the grant relates to – the rules apply on a project by project basis, not on the total R&D work undertaken in the year. If you have received Notified State Aid in relation to one project, this does not affect your ability to claim under the SME scheme for any remaining projects. Likewise, if you have received Notified State Aid in relation to non-R&D activities, this will not affect your SME claim.

Look at the long-term implications – remember, once you have received Notified State Aid in relation to a project, that’s it: there is no way back. Try to consider the long-term implication of receiving the grant and how it will affect future claims. Taking a small £10,000 grant at the early stages of a R&D project may help cashflow in the short term, however this could also affect the ability to claim R&D tax relief in future years.

Speak to people who know R&D tax relief – I might be slightly biased here but R&D tax relief is an ever-changing, complex area of legislation and it really does pay to speak to an expert to ensure that you are maximising your claim, whilst also planning ahead to avoid any potential pitfalls.  A quick chat at the beginning of a project can provide you with a clear and proactive action plan, leaving you with more time to run your business!

If you have any queries about R&D tax relief, Notified State Aid or De-Minimis State Aid related to investment, contact David Philp today at entrepreneur@chiene.co.uk.