In the second of a series of articles on Tax & Technology, Tim Shaw, associate partner with Ensors Chartered Accountants, looks at the UK’s R & D tax relief regime.

Notwithstanding the impending Brexit, the UK continues to be one of the most attractive locations for businesses to innovate and this is supported by the generous R & D tax relief regime. 

The financial impact of the support given by this legislation is huge. HMRC’s statistics show that £2.9 billion of R & D tax relief was claimed in 2015-16, an increase of 20 per cent over the previous year. 

Furthermore, since the launch of R & D tax relief in 2000, £16.5bn in tax relief has been claimed. Somewhat unusually, successive UK governments have actively promoted the reliefs available and have been supported by HMRC in this.

The legislation only applies to companies and to qualify for R & D tax relief, a company must be looking to develop new or improved products, software, processes, materials, services or devices that represent an advance in science or technology through the resolution of scientific or technological uncertainty. Mere commercial developments, or enhancements, of existing technology are not sufficient to qualify for the reliefs available.

The scope of the relief is broad, probably more so than was originally appreciated by the accounting profession. The reliefs can be relevant to almost any company, provided that the necessary conditions are met.  

Experience has shown that companies which may potentially claim the reliefs extend beyond those which would typically be associated with ‘R & D’ and claims are seen not just in respect of the expected sectors such as pharmaceuticals, software, biotechnology, FinTech, manufacturing and engineering but also sectors that have not traditionally been associated with innovation such as retail, construction, financial services and foodstuffs.    

There are now two applicable R & D tax regimes: the small and medium-sized enterprise (SME) scheme, and the R & D expenditure credit (RDEC) scheme for expenditure that does not fall into the SME criteria.

An SME for these purposes is defined, in broad terms, as a company that has fewer than 500 employees, and either annual revenues not exceeding €100m; or gross assets not exceeding €86m.

Where a company is connected with other enterprises (and this definition goes beyond companies), for example by membership of a group or through a significant (greater than 25 per cent) shareholder, the relevant details for the company’s “linked” and “partner” enterprises must be included when applying these limits to assess the company’s SME status.

Consequently, investment by private equity, venture capital or institutional investors should be carefully reviewed to establish whether a company is eligible for claims under the SME regime. Often such investment can push relatively small companies out of the SME scheme into the RDEC scheme.

The SME regime, which is the most tax advantageous of the two schemes, provides relief in two key ways.

Profitable companies which are tax paying can obtain an enhanced deduction equivalent to 230% (being the original expenditure plus a 130% uplift thereon) of qualifying expenditure (generally staff costs, subcontracted costs, consumables, software licences and a proportion of heat, light and power). 

This enhanced deduction can be used to reduce a tax liability in a current, previous or future tax year. Based upon a corporate tax rate of 19 per cent, this gives a £43.70 deduction per £100 of qualifying spend (being 230% x £19). 

For companies that are loss making, a more immediate relief is available. A claim can instead be made to surrender the full 230 per cent enhanced deduction for a cash payment at a rate of 14.5 per cent, giving an immediate cash flow benefit of £33.35 per £100 spent.  

This is therefore a direct cash flow subsidy to qualifying companies from the UK Government and whilst, deliberately set at a lower level of relief in percentage terms than if the enhanced deduction was instead retained as a loss carried forward or carried back to be used against prior profits, this provides welcome cash flow support.

Alternatively, the RDEC scheme is available to companies that fall outside of the SME size limits, or that are otherwise disqualified from the SME scheme (for example, due to receipt of subsidies or grants, or acting as a subcontractor to a third party).

Under the RDEC scheme, the benefit is delivered as a taxable “above the line” credit (i.e. in the main body of the company’s income statement, before the tax charge), based on 12 per cent of the qualifying expenditure in the period (giving an after-tax benefit of £9.72 per £100 of qualifying expenditure).  

The after tax above the line credit can be offset against corporation tax liabilities for profitable companies or claimed as a repayment by loss-making companies.

A company claims R & D relief through its corporation tax return and it is customary to file an R & D report in support of the claims made in order to reduce potential enquiries by HMRC.

The above is just a high-level summary of the appropriate legislation. As always with tax legislation it is not necessarily straightforward and professional assistance should be obtained before making a claim for R & D tax relief.

• For more details, call Tim on 01223 428314 or email: tim.shaw [at] ensors.co.uk