So you’ve had a good look at the activities of your company and think you might have a qualifying claim for Research and Development (R&D) Tax Credits – but what next?
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:
1. Prepare a short report that outlines the nature of the qualifying R&D activities for UK tax purposes
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:
- What is the science or technological advance sought?
- What were the scientific or technological uncertainties involved in the project?
- How and when were the uncertainties actually overcome?
- Why was the knowledge being sought not readily deducible by a competent professional in your field?
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.
2. Quantify your R&D tax qualifying costs
Qualifying costs for R&D tax purposes fall within 3 main categories:
- Emoluments paid to staff engaged in the qualifying R&D (this covers salary, employer’s NIC and employer’s pension costs). Make a table (say in excel) of all the staff engaged in R&D and their total emoluments for the year. Then apply a percentage based on the number of days they were directly engaged in the R&D v their total working days. Ideally your team keep timesheets but if not, an estimate based on diaries etc will suffice. Total these costs up and this will likely form the bulk of your claim.
- Subcontractors / Externally provided workers – These are third parties that you subcontracted elements of the R&D work to or workers provided by staff provider companies e.g. agencies, in the latter case. These relationships can sometimes be quite tricky to classify for HMRC R&D tax credits purposes and the paperwork will often be key.
- Software / Consumables can also be included in a claim. These will typically be bits of off-the-shelf software that you had to buy to use within the R&D process (e.g. licences) or bits of consumable kit or parts if you are developing physical products or prototypes. Really anything that is used up as part of the process or discarded. Any capital expenditure e.g. on PCs bought for the process, are not likely to be consumables for these purposes; rather these would attract 100% tax write off under the R&D scheme. Power and water costs can also be claimed. Ideally you would have a section of the building that you dedicate to the R&D activities so that you can section off the floorspace to calculate a proportion of the total power and water costs. Otherwise you would need to consider some other means of pro-rata allocation, perhaps based on the number of qualifying employees.
The total of the above costs will form the basis for your claim.
3. Apply the R&D tax uplift or enhancement to the total of the costs to calculate your R&D 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.
4. How to file the R&D tax credits claim with HMRC
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!