Two common R&D tax credit stumbling blocks for start-ups

Solar cell technology based on organic materials

Picture the scenario: a new technology startup. The founders invested £250,000 into the development of some new technology. The company is burning through the cash at a rate of knots and so they’re looking forward to recouping a chunk of it by claiming R&D tax credits under the ‘R&D tax credit scheme’ – something they’d heard about somewhere not long ago… In their minds, the tax credit had already been ear-marked for the next phase of work.

But two HUGE (yet surprisingly common) issues were about to put a hole through the R&D tax claim:

  1. Most of the costs were subcontracted to third party developers. This is fine in principle but under the R&D tax incentive rules such costs are restricted to 65% of the costs incurred (where the subcontractor is unconnected). The logic here is to eliminate the ‘profit’ element made by the subcontractor on the R&D work to get closer to an employee scenario. So here, in one swoop, almost half of the qualifying R&D costs and therefore claim had gone…!
  2. The company’s accounting period ended on 31 March 2012 and, for periods ending before or on this date, any R&D tax credit is capped by the PAYE / NIC suffered by the company in the period. This company had no employees (they’d subcontracted out all of the work) and had paid themselves no salary so there was £nil PAYE liability and therefore £nil repayable R&D tax credit. If the accounting period had ended just one day later, the company would have fallen within revised rules whereby the PAYE / NIC cap falls away. Ouch.

Of course, we should not lose sight of the fundamental issue of whether the company’s activities qualify for R&D tax purposes in the first place? If so, the company could still get a good result overall (a significant enhanced loss carried forward in the 31 March 2012 period end to offset against future trading profits and a potential repayable tax credit on qualifying activities and costs incurred in its next period ended 31 March 2013 and onwards) – just not perhaps as good as the founders had understood from the outset.

Fortunately, given the relaxation in the rules for accounting periods ending after 31 March 2012, the PAYE cap is no longer a problem – although it can still bite for retrospective claims (which can be made until 31 March 2014).

This is often a problem with tax incentives – there are almost always traps for the unwary…

Image: BASF – The Chemical Company via Compfight

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12 tax advantages of using a company as a business vehicle

  1. If the UK company taxable profits are £300,000 or less, a stand-alone company will normally pay corporation tax at just 21% (‘small companies’ rate’).
  2. This small companies’ rate reduces to 20% with effect from 1 April 2011.
  3. The standard rate of corporation tax is 28%. It will be reduced to 27% with effect from 1 April 2011 and there are plans to reduce it by 1% each year until the main rate is 24% by 2014. This rate applies to ‘large companies’ or those with taxable profits of £1.5m+ if stand-alone.
  4. Company structure allows for cash to be rolled up with low(ish) rates of tax suffered –  see points 1 and 2 above.
  5. Corporation tax is not payable until 9 months after the end of the accounting period for the majority of companies.
  6. R&D tax credits and other tax incentives are available for innovative companies.
  7. Remuneration strategies can be managed to optimise the personal tax position of investors and business owners.
  8. Investors in unquoted companies can obtain income tax relief on their equity investment e.g under Enterprise Investment Scheme (EIS).
  9. Shareholding investments in unquoted trading companies can attract 100% relief (exclusion from your estate) for inheritance tax purposes.
  10. Key employees can be incentivised through HM Revenue & Customs approved share schemes such as the Enterprise Management Incentive Scheme (EMI).
  11. Income on UK patents could be subject to a lower rate of corporation tax at just 10% (although unlikely to be introduced before April 2013).
  12. Companies within a corporate group (minimum of 75% common ownership of parent company) can shelter current year tax losses against taxable profits of other group companies.

More to come…

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