With almost a third of all R&D claims now being made by manufacturers and approximately £500m of relief finding its way to the industry, Deloitte’s Kathie Haunton and Sarah Goodman discuss how manufacturers approach their claims and what costs qualify for relief.
From 1 April this year, a new restriction was introduced for all R&D schemes on the consumable costs (e.g. materials and associated overheads) that qualify for tax relief.
It’s important for budget holders to understand how the changes will impact the cash savings they receive, as well as the practicalities of identifying the costs, which may be excluded from future claims.
HMRC has always been clear in its view that R&D relief should not be available to fund commercial production activities.
In a situation where R&D activities may co-exist alongside the commercial production activities though, it can be a challenging exercise for HMRC to satisfy themselves that the R&D claim only reflects the true costs of underlying R&D.
That said, claims have historically been accepted, as long as the start and end date of R&D element of the activity can be demonstrated and supported.
Under the new rules, R&D costs that relate to materials and overheads which are incorporated into products that are subsequently sold (typically trial batches and prototypes) will no longer be eligible for relief.
For example, take a manufacturer operating in the sub-sea oil and gas industry. R&D activity may be taking place to develop new products that are vast in dimension, such as valves, which require a working prototype to be built and used for testing the success of the work.
It may not be commercially, or economically, viable to scrap such items once developed and so the manufacturer may look to sell the prototype and recover some of their costs. In such a case, the costs associated with the materials used in the R&D activity, and incorporated into this item, will no longer be eligible for R&D tax relief.
These changes will require claimants to re-examine how they capture costs relating to prototypes, high value ‘first of class’ items and trials run on full scale production equipment.
The impact varies for different companies depending on how prototypes and the output from trials are used. In practice, companies now need to consider:
- Is it clear whether a product is ultimately sold? What is the ultimate destination of products used in trials?
- What is the timing between trials? Will it always be immediately obvious if a product will be fit for sale?
- How are costs attributable to a process identified? What are the differences between batch and continuous processing?
- What is a suitable sample size/methodology? Is this in proportion with the value of the materials and not over-burdensome?
- Can internal systems be updated to flag relevant expenditure on a “real-time” basis, so that it becomes easier to track?
It’s important to note that costs incurred on consumable items are not completely excluded from a claim. Any costs incurred on items that are scrapped, related to waste or are used up and transformed as part of the R&D, should still qualify for relief.
So for example, a food manufacturer is likely to scrap all of the output from any trials as health and safety standards will not allow the resale of these items. The costs of these materials should therefore still qualify for relief.
Likewise, if materials are recycled or discarded as sub-standard or damaged or part of a batch is retained for additional trials, these costs should also still be allowable in an R&D claim.
In addition, the legislation continues to allow for the appropriate proportion of software costs attributable to R&D to be included in the claim.
While some claimants may find that part of their qualifying R&D expenditure falls away, the good news is that the Government has continued to show its support for incentivising R&D in the UK, with the value of the relief increasing for all claimants from 1 April 2015.
Small tax paying companies can now realise a benefit of up to 26% of their qualifying R&D expenditure, while companies claiming under the ‘large’ scheme can recover up to 8.8% of their spend.
Loss making SMEs can claim a repayable tax credit worth 33% of their R&D spend, with large loss makers able to receive an 8.8% credit in cash. The regime therefore still offers great cash flow advantages to manufacturers undertaking qualifying R&D, regardless of their size.
The Government also continues to focus its efforts on increasing awareness of R&D tax relief among smaller firms, and has announced that new guidance and measures will be introduced this summer.
These measures will include the introduction of a voluntary advance assurance scheme for smaller businesses making their first R&D claim, a reduction in the time taken to process a claim for such companies from 2016, and a publicity campaign to increase awareness of the relief.
With all of the above change, businesses are encouraged to consider the impact the new rules may have on the value of their R&D claim. They should think about whether all the potential areas of R&D activity have been identified and how effectively relevant costs are captured, to ensure that the true costs of the underlying R&D are included in their claim.