There are a number of R&D funding tax relief programmes for UK manufacturers of all sizes, as Rem Noormohamed and Sam Dooley, from international law firm, DWF LLP, explain.
Independent international analysis of the UK R&D tax incentive regime indicates that 10% of UK private sector research spend would not have taken place without the availability of R&D tax relief.
This might sound modest, but with R&D spend being highly correlated to future productivity growth, a multiplier effect exists. It’s estimated that the average return on tax-incentivised R&D spend is 2.6 times, before taking into account the benefit of available tax incentives over the lifecycle of the investment.
Upfront incentivisation comes in two forms, depending on whether the company is a small or medium enterprise (SME) on the European definition. The SME form of relief is more generous, and applies to companies (which are not subcontractors of larger concerns) with an annual turnover under €100m and a balance sheet under €86m.
The SME Scheme
SMEs receive an additional 130% allowance for qualifying R&D expenditure on top of the deduction for such expenditure. At current corporation tax rates this means that additional expenditure on research and development, for a profitable company, reduces current tax payable by 46p for every pound spent.
Loss making companies are permitted to convert the allowance into a payable tax credit worth 14.5% of their R&D expenditure for the year (or the amount of their trading loss for the year if lower).
If they choose not to convert to payable credits, the enhanced loss will be carried forward to be used against future profits. In this way we can see that there is a powerful incentive for SMEs to invest in qualifying R&D, through the profit cycle.
The Large Company Scheme
Larger companies can claim a payable credit of 11% of qualifying expenditure under the UK’s R&D Expenditure Credit Scheme. This credit is treated as grant income subject to tax for the company.
Qualifying expenditure will include the company’s in-house expenditure on R&D, but not expenditure subcontracted to other companies. Contributions to external independent research and expenditure sub-contracted to the university sector can also qualify for credits under the large company scheme.
The amount of credit claimable under the large company scheme is in principle unlimited, and HM Revenue & Customs accordingly take a risk-adjusted approach to the monitoring of claims.
First claims by a company not previously incurring research expenditure, and all claims on expenditure in excess of £25m, will be subject to central review by HMRC specialists.
Additionally, (for so long as the UK remains a member of the European Union) credits received qualify as EU State Aid and all companies in receipt of €500,000 or more (or the sterling equivalent) will have details of their funding published by the European Commission on its website.
Tax through the life cycle of the product
Any discussion of R&D expenditure, and the UK system for encouraging it, is incomplete without comment on the increasingly beneficial tax regime for products developed through domestic research expenditure once they become income-generative.
Firstly, the UK has moved to a territorial system of taxation, such that companies generating income from their IP rights via overseas sales or royalties will only pay UK corporation tax on sales to the domestic market. This dovetails with the UK’s extensive network of double tax treaties which reduce or eliminate foreign taxation on royalty payments to the UK.
Secondly, the UK makes available to companies that wish to adopt it the “patent box” tax regime which, since 1 April 2013, reduces the corporation tax rate on profits relating to patented products or algorithms to 10%. To benefit from this, the company must own the patent in question or have an exclusive licence to it.
Prompt filing of patents and claiming entry to the “patent box” regime for existing products is beneficial, as the regime will shortly become harder to enter. Under internationally agreed rules, the UK began to tighten the patent box regime for newly patented products from 1 July 2016 – restricting the categories of qualifying patents to those where the commissioning company can show a closer connection or nexus between its in-house R&D work and the patent ownership. Pre-existing patented IP will continue to qualify for the lower tax rate on related income.
Points of action
Rem Noormohamed, Partner & Head of Advanced Manufacturing and Engineering, DWF LLP:
“Whether you are a manufacturer or not, if your business is already spending on developing its product portfolio and/or manufacturing processes, we would strongly encourage you to review your expenditure carefully to identify which elements of expenditure will qualify for tax relief.
“If your products and/or processes are capable of patent protection, then it is critical that you avoid any delay in getting your first filing of your patent application into the patent office to obtain your ‘priority date’. Your ‘prioity date’ is important as it will be used to establish the novelty and/or non obviousness of your particular invention relative to everything in the public domain before your ‘priority date’ (also referred to as the ‘state of the art’).
“In addition to protecting your commercial and legal interests in via your grant of patent, it may also be possible to shelter future income at the lower 10% patent box tax rate.”