I could probably give you 25 misconceptions that I hear on a daily basis but, for now, here are 5 common misconceptions regarding the UK R&D tax relief:
Please get in touch if you’d like to learn more – plus no doubt allow us to dispel the other 20 misconceptions…!
In this free webinar, Steve Livingston (Founder & MD of ip tax solutions) walks Founders and Entrepreneurs through the basics of the UK R&D tax credit incentive.
This is a ‘back to basics’ seminar for company founders / entrepreneurs who would like to learn more about the Research & Development tax incentive and whether it might apply to their business.
This free webinar lasts 55mins
As an ambitious entrepreneur and founder of a fast growth business you may benefit from reviewing the following generous tax breaks as part of your 2013 planning:
1. Patent box – introduced with effect from 1 April 2013, companies will be able to elect into this new beneficial company tax rate and pay tax at just 10%. This new rate of corporation tax will be phased in over a four year period.
Innovative UK companies should be taking steps now to ensure that their patents qualify and apply across the widest possible range of products and services to maximise tax savings.
2. R&D tax relief – the SME R&D tax relief continues to get better and better with the enhanced corporation tax deduction now at 225% with no de minimus spend nor PAYE cap on repayments.
Average claims are approx £40,000 yet less than 1% of UK SMEs claim it – are you missing out?
3. Entrepreneur’s relief – when you come to sell the shares in your company you could benefit from this preferred rate of capital gains tax of just 10% on the first £10m of lifetime gains. You must be an officer or employee of the trading company and hold at least 5% of the ordinary shares and voting rights for the 12 months leading up to disposal of the shares to qualify.
You must ensure that the qualifying conditions are not (inadvertently) breached especially if a sale is on the cards in the foreseeable future.
4. EMI share options – the Enterprise Management Incentive share option scheme (EMI) has long been an attractive tool for retaining and incentivising key employees, however, it’s about to get even better….
It has been a long running source of frustration that the option holders struggled to satisfy the requirements of entrepreneur’s relief (ie they rarely tick the 5% share holding requirement nor the 12 month minimum holding period), however, changes are afoot to allow option holders to accrue their 12 month qualifying holding period from the date of grant and for sub 5% holdings to qualify. This promises to be a great development.
5. Seed Enterprise Investment Scheme (SEIS) – raising funding for early stage (< 2 years) trading companies is made a whole lot easier when the investors can receive a 50% income tax break on the funds invested (potentially up to 78% tax relief up until 5 April 2013)!
Companies are limited to £150,000 in total under SEIS whereas individuals have a £100,000 annual investment allowance.
These are just a handful of potentially lucrative tax breaks that should be high on your agenda if you are to release much needed cash into your business and get off to a cracking start in 2013!
“Has anyone ever done an exercise on a company with a director say on £9000 salary per annum and £40k dividend v a director on £say 54K pa .Both doing 60% R&D . Say Profit £80 before salary and dividend . What goes to HMR&C and what cash does company retain in bank ? Bound to be someone keen to look at that ?”
Using the above example, I have tweaked it slightly to an overall director’s remuneration package of £42,475 (rather than £54k). This is because, if a director would like a remuneration package around this level, this figure makes better tax sense as it uses the personal allowance and basic rate tax band (tax year 2012/13) with no income subject to higher rate tax.
Taking a baseline control position first, it is generally more tax efficient for a director/shareholder to extract profits from a company as a dividend rather than salary.
For these purposes, I have assumed that in the dividend scenario the director has utilised the personal tax free allowance of £8,105 then taken the remainder as dividend up to £42,475 (there is a marginally more tax efficient way to structure this but I am trying to keep things simple).
Dividends received within the basic rate tax band attract no further income tax plus no NICs for the director.
However, the company tax suffered is higher as dividends are non-tax deductible whereas salary is deductible for tax.
Nevertheless, the director would be better off in the dividend scenario to the tune of a £5,000 saving compared to a salary taking into account both net cash left in hand and in the company (post tax).
However, once we take R&D tax credits into account then the position reverses…
If we assume profits of £80k pre salary / dividend and that the director is engaged 60% in qualifying R&D and receives the 225% R&D uplift on salary costs then the director will be approx £6,000 better off receiving a salary compared to receiving dividends. Note that there can be no R&D uplift on dividends received – only on salary.
This is some £10,000 improvement in tax savings from the baseline control position of salary and no R&D tax credit claim.
This shows that the default response of:
“A dividend is more tax efficient than a bonus”
can adversely impact on the overall tax profile of an owner managed company where R&D tax credits are available.
This is another example of the need to view a business and its shareholders’ tax position holistically – it all connects; it is dangerous to seek advice on one aspect of your financial and tax affairs without it having a knock-on effect elsewhere in your overall tax profile.
It is vital to crunch the numbers before agreeing a tax optimised remuneration package if you are to make the most of the UK’s fantastic R&D tax incentive scheme.
Latest HM Revenue & Customs figures reveal that a total of £52m tax relief was claimed in the North West under the UK R&D tax credit scheme in 2010-11.
The £52m is spread over 985 claims giving an average claim of £53,000 (interestingly, this compares with an average claim of just £19,000 in London!), although this includes large company claims which can be significant. However, even when claims by large companies are split out North West SME companies claimed an average of £32,000 in tax relief.
This is good news for local North West companies and the number of claims made was 3rd highest overall after the South East (1) and London (2).
Overall, out of the almost 5 million SMEs in the UK only 8,140 R&D tax claims were made in 2010-11 and less than 1% of UK SMEs have made a claim for enhanced R&D tax relief since its introduction in 2000. I find this statistic staggering.
What should you do now?
If you are looking at starting a new hi-tech venture then the timing has never been better in utilising the latest available UK tax incentives.
Consider a scenario where say 4 enterprising entrepreneurs are looking at building a new state of the art technology platform.
They budget it will cost c£1m to get to market but know they can prove the concept with c£100k-£150k.
But there’s a problem – cashflow is tight….
This is where a bit of forward tax planning can help.
Firstly, they could set up a new company to undertake the venture. They could then structure the shareholdings such that no shareholder and director has more than 30% of the shares and subscribe for shares under the Seed EIS Scheme (SEIS). The company would need to obtain certification that it is SEIS qualifying and it would be well advised to seek advance assurance from HMRC.
A company can raise £150,000 in total under SEIS so each of the four shareholders could subscribe £37,500 for 25% of the ordinary shares.
Under SEIS, each shareholder would be able to reclaim 50% income tax relief on their investment – so £18,750 income tax relief could be claimed by each shareholder amounting to a total £75,000 tax saving.
But there’s more….
The company could use the funds to engage in a qualifying SEIS trade of preparation for a trade by carrying out R&D activities. The R&D work could fall within the R&D tax credit regime which allows for a 125% uplift in qualifying spend for SMEs and capacity to claim a tax refund in situations where the company is loss-making – this will almost certainly be the case based on our facts as the company is pre-revenue.
So say the company invests the £150,000 into qualifying R&D in its first year then the company would be eligible to deduct a further £187,500 for tax purposes i.e. 125% * £150,000.
The company would suffer a tax loss of £337,500 and could either carry this loss forward to offset against future taxable profits or it could elect to surrender the tax loss in return for a tax refund. The refund is restricted to 11% of the enhanced R&D tax spend which equates to £37,125 cash back from HMRC.
Once the SEIS cash has been exhausted they can seek further funding under the less favourable (but still hugely attractive) Enterprise Investment Scheme (EIS). Further R&D tax credits should be available in later years too whilst the R&D activities continue.
So our new venture has succeeded in deploying £150,000 of funding and expenditure at a net cost to the founders of just £37,875. SEIS and R&D tax incentives have effectively provided the additional £112,125 cash funding!
This scenario does not take into account the possibility of some or all of the SEIS shareholders taking advantage of the one-off capital gains exemption on gains reinvested in the tax year to 5 April 2013 – we’ll leave this for another post as the tax savings are staggering!
Hopefully this illustrates that with just a bit of forward planning and by seeking some professional advice, it is amazing how you can conjure up much needed additional cash to fund worthwhile ventures.
HMRC R&D tax credits can be successfully claimed by UK companies across all industry sectors – from builders to engineers to manufacturers to technology firms to, of course, R&D companies.
There are 4 key steps to making a successful claim for HMRC R&D tax credits:
Firstly, breakdown the project(s) work carried out in your company over the past two years into potential qualifying and non-qualifying projects.
Consider which projects you feel pushed the boundaries of knowledge in your field. For example, you may have found yourself at point A and wanted to get to point B in terms of product or service delivery but had no idea how to get there? You therefore incurred time and costs on competent professionals in your sector seeking to find potential solutions. You may have hit roadblocks along the way?
If so, these can all be pointers towards potentially qualifying R&D activities for tax…
You should aim to build your supporting R&D report around 4 key headings:
HMRC deals with R&D tax credit claims via its specialist R&D Units – I have to say the team that work at these offices are amongst the most helpful and pragmatic of all the HMRC departments (praise indeed!). Your report will be sent to your closest R&D Unit.
Qualifying costs for R&D tax purposes fall within 3 main categories:
The total of the above costs will form the basis for your claim.
The enhancements set out below apply for UK SMEs which will cover the majority of readers of this site as the thresholds for R&D are huge (less than 500 employees and either turnover of less than €100m or a balance sheet total of less than €86m).
From 1 April 2011, the enhancement is 200% (it was 175% in the year up to 1 April 2011).
From 1 April 2012, the enhancement is 225%!
[Update: From 1 April 2015, the enhancement is 230%!!!]
So say your total qualifying costs (from points 1-3 above) in your financial accounting period ended 31 March 2012 are £234,235, then under this R&D tax incentive you will receive an additional £234,235 deduction against your taxable profits for the year (for company corporation tax purposes only).
Taking this a step further, say your profits adjusted before tax (but pre R&D uplift) are £125,000, then this additional R&D adjustment will turn an otherwise likely corporation tax bill of £25,000 into a tax loss of £109,235. Not only does this eliminate the £25k tax bill but it potentially results in a tax refund from HMRC of £13,654! (any refund is capped by the PAYE paid by the company, although this rule falls away from 1 April 2012)
Now you can hopefully see the value of investing some time to pull together an R&D tax credit claim!
If your financial accounting period straddles the 1 April change of rates (say a 31 December year end) then you need to apportion expenditure pre and post this date.
You can go back to accounting periods ended in the past two years to make or amend claims so its not too late to revisit and amend previously filed corporation tax returns.
The R&D tax credit claim is included in your corporation tax return for the relevant accounting period. Corporation tax returns are filed online. Your report is sent to the relevant R&D Unit after filing the return online.
There is some work to be done before the claim is filed to determine the optimum treatment of the R&D claim for your specific circumstances. For example, rather than reclaim the cash tax credit, it may work better for you to carry a resulting loss back to the previous profitable accounting period or carry forward to future periods if you expect to return to profitability quickly.
This is especially important because the R&D tax credit repayment option gives you a discounted return than if you held out and offset the enhanced deduction against future or past profits at your full corporation tax rate. Even though the enhanced deduction increases to 125% from 1 April 2012, the repayment position does not improve. Watch out for this!
You can attempt to make a claim yourself or you could try using HMRC’s new R&D pilot programme although you may find you will achieve a better result by seeking some professional help from R&D tax credits specialists.
Either way, I hope the above is helpful and we see more R&D claims being filed by UK companies!