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|
|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|
|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|
| || |
|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|
|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|
|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|
| || || |
|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 firstname.lastname@example.org.