Research & Development (R&D) tax relief is a measure that was introduced almost two decades ago to incentivise innovation in the UK. This corporation tax relief reduces a liability or in certain circumstances results in a payable tax credit, either way increasing cash to spend in the business, and therefore also benefitting the economy as a whole.
The definition of what constitutes R&D is wide ranging but is often misunderstood, and as a result, the relief may be missed or overclaimed. In general terms, if your engineers or technical team spend time improving products or processes or developing solutions to technical problems, performing feasibility assessments or trying to find solutions through iterative processes, or trial and error, then this may qualify.
If your team encounters failures, technical challenges or issues in the course of their work, or the completion of a project takes longer than expected, this could also indicate the presence of qualifying activities.
There are two different schemes depending on the size of a business:
- This scheme gives an additional tax deduction of 130% of the qualifying costs (i.e. a total of 230%). This will provide an additional tax saving of 24.75p for every £1 spent (130 at the tax rate of 19%). Loss making companies can surrender up to the entire 230% for cash at a rate of 14.5%, thereby receiving up to 33.35p of cash for every £1 spent.
- For costs incurred from 1 April 2023, the additional deduction will reduce to 86%, providing an additional tax saving of 21.5p for every £1 spent (86 at the tax rate of 25%). Loss making companies can surrender up to the entire 186% for cash at a rate of 10%, thereby receiving up to 18.6p of cash for every £1 spent.
- A larger business is defined as one where the entire worldwide group has over 500 employees and either turnover in excess of €100m or gross assets over €86m, and they are eligible for the Research and Development Expenditure Credit (RDEC).
- The RDEC is a 13% credit that appears within operating profit, thus increasing EBITDA. This amount is then subject to tax at 19%, and so the net benefit is 10.53p for every £1 spent.
- The RDEC will increase to 20% for expenditure after to 1 April 2023 (with a net benefit of 15%).
There are five key costs that are eligible for R&D tax relief:
- Staff costs – the sum of gross salary, bonuses, employer’s social security and pension contributions, for each staff member, to which a percentage is applied based on the amount of time that they spend on R&D activities.
- Subcontractors – individuals or firms that undertake a specific part of a project. As well as an eligibility percentage as with staff, a 35% restriction is also applied, to reflect the fact that there will be a profit margin and other ineligible costs built into the price charged.
- Externally provided workers – individuals that work for the company, effectively as staff, but are not on the payroll (e.g. temporary labour through an agency). As with subcontractors a percentage is applied and there is a 35% restriction.
- Software – Licences paid for software that is used for the R&D work (unfortunately hosting costs do not qualify).
- Consumables – any materials that are used up in the R&D process and are not incorporated into products that are sold on.