SMEs making successful claims for research and development (R&D) tax relief can expect to see sizeable percentage reductions in their corporation tax liabilities because they are able to claim relief for an additional 125 per cent of the qualifying costs they have incurred.
If the relief extinguishes taxable profits and results in losses, these losses can be used in a number of ways; they can be:
- Carried back for a 12-month period, resulting in a refund of corporation tax previously paid
- Carried forward to offset against future trading profits
- “Cashed in” by exchanging the losses for a tax credit – currently 14.5 per cent of the qualifying loss
Although awareness of the availability of R&D tax relief and credits is high, many companies do not appreciate that they are involved in qualifying projects and are entitled to claim relief. The perception seems to have remained that R&D must involve some form of laboratory research, yet the reality is very different – many companies have pursued successful claims for software development, even where this development is not their core business.
In addition, if your company is subcontracted to carry out R&D by another company, although you cannot claim relief under the SME rules, you can claim relief under the large company rules if the contractor company is itself large, or is for example a charitable body.
The following projects have all been accepted by HMRC as qualifying projects:
- Internal development of new web-based customer relationship management system
- Development of an internal bespoke time recording and billing system
- Translation of software into foreign languages
- Development of iPad and iPhone applications
- Subcontracted development of bespoke software applications
In determining whether your project might qualify for relief, it is important to be aware of the following issues.
An R&D project must have a clear start and end date. The development cannot simply be as a result of a “eureka moment” but must involve development over a period of time, even where that period of time is relatively short.
The purpose of the project should be to provide improved functionality to that which is currently available in the market place. The fact that others may be separately seeking to develop the same improvements, or in fact the project may fail, will not of itself mean the project doesn’t qualify.
Resolving scientific or technological uncertainty
It is important to appreciate that R&D tax relief is only available to companies undertaking “trade related” projects that seek to achieve “an advance in overall knowledge or capability in a field of science or technology through the resolution of scientific or technological uncertainty”. This is different to using existing knowledge or capability to improve existing systems or develop new systems.
HMRC will want to see that real scientific or technological uncertainties exist which the project seeks to resolve. Often when embarking on a project there is very little knowledge available from other professionals working in the same field to indicate whether the project is technologically feasible or how it might be achieved, and this in itself can be sufficient uncertainty.
The condition “trade related” means undertaking R&D that may lead to a trade or facilitate an extension of an existing trade. Merely undertaking R&D work does not in itself constitute a trade; the company should be involved in producing or intending to produce goods or services to its customers that are improved by the R&D project. This can be broad, so for example a software development company obtained R&D tax credit relief of £250,000 after an enhanced claim in excess of £1m was approved for a new software system developed by the company to improve its own internal processes.
Systematic investigative work
When assessing an application, HMRC will want to understand what the overall aims of the project were, and what systematic work was carried out in arriving at the outcome.
A time-line showing how and when technological uncertainties were overcome is useful; a successful claim will typically detail how the company overcame the uncertainties and the investigations and analysis undertaken to demonstrate the complexity.
Which costs qualify for R&D relief?
Apportioning costs is a complex area because different rules apply according to whether you are using employees or agency staff or are subcontracting out the R&D project, and if the latter, lower rates of tax relief typically apply. In every instance, costs claimed must be apportioned by reference to how much of a “resource” was used wholly and exclusively for the qualifying R&D project. For example, for an employee spending 70 per cent of his or her time on the project, 70 per cent of their cost can be claimed, with the remaining 30 per cent not being eligible for the additional relief.
Allowable costs include:
- Staff costs for specialist staff working on the project, based on the time spent. Costs which can be claimed are gross salaries, employers’ national insurance contributions and employers’ pension contributions. It is important to include the professional backgrounds of individuals working on the project, and the work they did within the project
- R&D work subcontracted out – special rules apply to the relief that may be claimed; for unconnected parties relief is restricted to 65 per cent of the costs; and for connected parties relief is restricted to the qualifying expenditure incurred by the subcontractor
- Agency workers
- Software and items which have not been capitalised but have been used exclusively in, and “consumed by” the R&D project
For example, a digital design studio specialising in mobile and multimedia applications obtained 125 per cent tax relief to offset the cost of software developers based on timesheet reporting, restricted subcontractor costs and software and testing costs. Because the company had trading losses, they had no corporation tax liability for a number of years and could instead reinvest that money into developing the business.
Some questions to ask yourself
If your company is engaged in projects that could qualify for R&D tax credits, start asking yourself the following questions. If you can answer positively to each one, there is a good chance you would be eligible for some tax relief.
- Are you working on an innovative project?
- Does your project have a defined start and end date?
- Is it in a field of science or technology?
- Is the work you are doing improving what is currently available in the marketplace?
- Are you pursuing a scientific or technological advancement?
- Is there a degree of scientific or technological uncertainty involved?
- Is the knowledge or capability involved readily available? Or is it deducible by a competent professional?
- Are you spending time investigating and testing the results?
Lesley Stalker is a tax partner at accountancy firm RJP and has experience in helping companies make R&D tax relief claims.
Read more on R&D tax credits:
- R&D tax credits aren’t just for engineering firms
- Tax relief schemes: Are you taking advantage?
- R&D tax credits could support innovation
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