Changes to the R&D tax relief scheme for small and medium enterprises can allow companies to triple their tax benefits and provides access to cash, say tax consultants at Ernst & Young.
Research and Development (R&D) Tax Relief
Thousands of companies every year use the UK’s research and development (R&D) tax relief scheme to help them develop and improve technology that reduces costs, increases quality or leads to new or improved products, processes or services. Claiming R&D tax relief can provide additional funding for R&D and help companies remain competitive by reducing the tax bill and improving cash flow.
SME regime broadened
Depending on the size of the company, R&D tax credits can be claimed under either the small and medium sized enterprise (SME) or large company schemes.
Recent changes to the SME R&D tax scheme mean that some large companies have been able to convert to SME status. These companies may be able to triple their tax benefits (and potentially receive cash credits), which is particularly important in today’s economic climate where companies need to take advantage of all the benefits available to them to help them to survive the downturn.
However, many manufacturing companies are overlooking this worthy incentive as they do not appreciate just how broad the definition of R&D for tax purposes is (R&D has a specific statutory meaning for tax purposes that is not the same as the commercial meaning of R&D). Many manufacturing companies are likely to be undertaking some level of eligible R&D work, which will entitle them to make a claim.
This article discusses the changes to the SME scheme and the most commonly missed opportunities companies face when filing R&D tax relief claims
What are the changes to the SME scheme?
A number of recent changes have been made to the SME R&D tax relief scheme:
1 Extension of SME R&D relief to midsized companies
The SME relief scheme was extended to include larger SMEs or mid-sized companies. Companies (or groups of companies) with up to 500 employees and either a turnover not exceeding 100m Euros or an annual balance sheet not exceeding 86m Euros, may now claim under the SME regime . Many companies may find they have now switched from large to SME status.
2 Enhanced tax benefit
The level of enhanced deduction for eligible R&D expenditure has been increased from 150% to 175% for all SMEs.
3 Payable credit in cash
The amount of payable cash credit has been reduced slightly from 16% to 14%; however, the rate of cash credit that may be claimed where companies are in a loss making position has stayed the same at approximately £24, for every £100 of eligible spend.
Has your company status changed from large to SME?
Clearly, there are significant benefits for large companies now qualifying as an SME. The new size criteria and benefits apply for expenditure incurred on or after 1 August 2008. However, there may be some complexities in preparing an R&D claim if the company status has changed under the new definition. Obtaining professional assistance from a specialised R&D tax advisor may help the company take account of some of the additional conditions which need to be fulfilled (which are not relevant to the large company scheme).
1 Ownership of intellectual property
All intellectual property resulting from the R&D must generally vest with the claimant company.
2 Subsidised expenditure
Where a project has received any funding which is a notified State Aid, no expenditure on that project can qualify under the SME scheme.
Where any other subsidy or grant is received, generally only amounts relating to the grant/subsidy are excluded from the SME scheme.
3 Contracted R&D
The company filing the R&D claim must not have been contracted to carry out the R&D.
4 Subcontracted R&D
Companies can include payments made to subcontractors, a cost category which is generally not available to large companies. Expenditure is generally restricted to 65% where the companies are unconnected.
Generally, eligible cost categories are similar to the large company scheme and focus on the costs of people undertaking the R&D (including augmented headcount), consumables used up in the R&D, software costs and utility costs. The SME regime is more generous than the large company scheme as it also allows qualifying companies to claim additional cost categories.
Breadth of the R&D regime
Due to misconceptions around the definition of R&D, many manufacturing companies are not aware that they are eligible to claim R&D tax relief on some of their day-to-day business activities. One of the key misnomers assumes that relief is restricted to companies carrying out blue-sky research only, typically found in pharmaceutical companies or research institutes.
The key considerations in determining whether a project qualifies for relief under the SME and large schemes are whether the Government’s criteria for R&D are satisfied (as defined by the DTI guidelines issued March 2004). These rely on a two-stage test, which states that potentially eligible activity should be seeking to achieve a technological or scientific advance by overcoming technological or scientific uncertainty. The two criteria interact to significantly broaden the scope of potentially eligible activity.
Examples of areas which may contain potentially eligible R&D:
1 Creating new products or making appreciable improvements to existing products
2 Developing or improving manufacturing processes and scale-up trials that are designed to increase production efficiencies, reduce waste or decrease costs
3 Integration of new technology to an existing processes that facilitates manufacturing improvements
4 Adaptation of new technologies from another industry to develop new or improved devices, processes or products that were not straightforward
5 Advances in business support and operational tools, development of network and management technologies, including designing mobile and interactive services
6 Integration of legacy and new systems, for example following corporate mergers or acquisitions, adoption of an Enterprise Architecture or for joint ventures with external partners.
Are you maximising your R&D claim?
If your company is already making an R&D tax relief claim, you may want to consider whether all qualifying activities are being identified and claimed.
The key to unlocking and maximising your R&D tax benefit is being able to identify successfully the eligible R&D activities amongst a company’s wider operational activities and this may not be straightforward.
How to claim R&D tax credits
You can claim cash back for activities undertaken up to two years ago. R&D claims must be submitted to HM Revenue & Customs (HMRC) within two years of the end of the relevant accounting period.
Typically, when submitting a claim, it will be necessary to demonstrate how the technical activities in question meet the criteria for R&D and provide support for the expenditure being claimed. As a self-assessment scheme, it is the technical competent professionals (engineers and IT developers) within your company that determine what is an eligible R&D activity. A good way to explain to HMRC how the criteria for R&D have been met is to submit, with your claim, a sample set of project descriptions detailing eligible activities. This can be a difficult task, given that HMRC does not publish recommendations on how technical reports should be structured.
The SME regime changes provide an excellent opportunity for companies with up to 500 headcount to triple their tax benefits and potentially convert the relief into cash. Companies should act now to determine whether they could reap the rewards for their R&D activity. However as the process can be complex, seeking advice from a specialised R&D tax advisor may help companies take full advantage of the benefits available to them.
All three authors are with Ernst & Young’s Research and Development Tax group in the UK. Frank Buffone is the partner leading the R&D tax practice. Sian Rayson-Mounsey is a senior R&D tax technical and methodology advisor. Roxane Naro Markarian is a senior manager with an engineering background and experience in preparing and agreeing R&D tax claims within the manufacturing sector.