r&d tax credits

Optimising directors remuneration plus R&D tax credits

So here’s a recent conundrum posed at an R&D Tax Credits Group on Linkedin:

“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.

 

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North West SMEs claim an average £32,000 R&D tax relief

Salford Quays & BBC MediaCity UK - The Tram

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?

  1. If you haven’t already reviewed your company activities to determine whether you have a potential R&D tax credit claim you should do this asap – there is a timelimit for backdating claims.
  2. If you have made R&D claims, compare your claims with the averages noted above and if your claim was for less than £32,000 consider whether it is worth getting a second opinion – you can amend claims if they are still within the two year timelimit.
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Mix SEIS + R&D Tax Credits to Maximise your Start-up Funding

Taxes

Taxes (Photo credit: Tax Credits)

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.

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HMRC R&D Tax Credits: How hard is it to file a claim?

HMRC R&D Tax Credits - How to file a claim

(Updated: July 2019) 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 UK 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 or capability in your field (not just for you as a company).

For example, you may have found yourself at point A in a new project and wanted to get to point B in terms of say, a new or improved product or service but had no idea how to get there? You therefore incurred time and costs engaging competent professionals in your sector seeking to find potential solutions.

You may have hit roadblocks along the way and therefore incurred commercial and financial risk.

Don’t forget that aborted projects can also be included in a claim.

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 four key headings:

  1. What is the science or technological advance sought?
  2. What were the scientific or technological uncertainties involved in the project i.e. why was it that standard or commonly accepted approaches or methodologies wouldn’t work in your case?
  3. How and when were the uncertainties actually overcome? Take us on your development journey. What worked and what didn’t?
  4. Why was the knowledge being sought not readily deducible by a competent professional in your field? It helps here if you can provide a little info on the background and experience of the team that you had involved in this project.

There are specific HMRC guidelines for claims made by companies in the field of software development including some example case-studies of qualifying projects for R&D tax purposes.

HMRC deals with R&D tax credit claims via its specialist R&D Units.

2. Quantify your R&D tax qualifying costs

Qualifying costs for R&D tax purposes fall within 3 main categories:

(i) 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) listing all of the staff engaged in the R&D project(s) and their total emoluments for the year. Then apply a percentage based on the number of days that they were directly engaged in the R&D project work (v their total working days).

Ideally your team maintain time-sheets 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.

(ii) Subcontractors / Externally provided workers – These are third parties that you subcontracted elements of the R&D work to or workers provided by a staff provider e.g. agency, in the latter case.

These relationships can sometimes be quite tricky to classify for R&D tax credits purposes and the paperwork will often be key.

(iii) Software / Consumables can also be included in a claim.

These will typically be off-the-shelf software that you had to buy to use within the R&D process (e.g. software 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 (if not already securing 100% writing down allowances under the normal Annual Investment Allowance available to all companies).

A percentage of your power and water costs can also be claimed.

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 SME 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 2015, the enhancement is 230% on qualifying costs.

So say your total qualifying costs (from points 1-3 above) in your financial accounting period ended 31 March 2019 are £150,000, then under this R&D tax incentive you will receive an additional £195,000 deduction against your taxable profits for the year. This is for company corporation tax purposes only i.e. it is a ‘notional’ tax deduction only that does not reduce your profits for accounts purposes.

This means that you have less profits subject to corporation tax so it reduces your bill.

Taking this a step further, say your adjusted taxable profits (but pre-R&D enhanced deduction) are £125,000, then this additional R&D adjustment will turn an otherwise likely corporation tax bill of £23,750 into a tax loss of £70,000. Not only does this eliminate the c£24k tax bill, but it potentially results in a tax credit rebate of £10,150 from HMRC (at 14.5%)!

Now you can hopefully see the value of investing some time to pull together an R&D tax credit claim!

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 R&D report and accompanying calculations can be filed online via the HMRC filing portal. They will be passed internally to the relevant HMRC R&D Unit for processing.

HMRC aims to process all R&D tax credit claims within 28 days of filing.

Getting the best R&D tax result for you

There is more work to be done before your R&D tax claim is filed with HMRC. This work is to determine the optimum treatment of the claim for your specific circumstances.

For example, rather than reclaim the cash tax credit at 14.5%, it may work out 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 because the net cash recovery might be higher than simply claiming the in year tax credit.

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 achieve a better result by seeking some professional help from R&D tax credits specialists.

Either way, I hope that the above is helpful and we see more R&D claims being filed by UK companies!

 

You can find a more detailed R&D Tax Credit Guide at our sister site: IP Tax Solutions.

R&D tax credit “production” confusion!

There has been this ongoing problem for companies that are solving technological or scientific uncertainties (and therefore,on the face of it, qualify for research & development enhanced tax relief) yet the product that emanates from this R&D process is ultimately sold to a customer e.g. a prototype that is sold rather than skipped.

HMRC’s view has been that if the product was sold it must represent excluded “production” activities rather than a qualifying R&D process and therefore cannot be qualifying expenditure.

The thinking here is that the R&D tax credit exists to encourage investment in the advancement of scientific or technological knowledge where there is no alternative market driver so, on the flip-side, if there are customers willing to purchase the fruits of your labour then why do you need the tax credits? But this analysis does not stand up to economic scrutiny for 99% of SMEs; in that you may not have known how to achieve what you ultimately created but, if you are successful, why on earth would you want to dump your invention or prototype in the skip if there happens to be a willing buyer?!!

The good news is that recent HMRC guidance has softened this approach. It is not a complete reversal of policy but rather an acceptance that there may be instances where costs of developing products do qualify for the R&D tax relief despite ultimate sale.

A key takeaway from this will be the heightened need for appropriate documentation to evidence when the qualifying R&D ceased and excluded “production” activities commenced.

An improvement to this tricky area – yes – but does this go far enough? How might this impact on your company’s R&D activities and future potential claims?

1 April is no joke for UK companies!

1st April is an important date for UK companies as it signifies the start of a new tax year (yes, the personal tax year is different running to 5 April each year) and there have been some important announcements made in recent Budgets. Here are the headlines:

1. Small companies rate of corporation tax falls from 21% to 20%.

2. Standard rate of corporation tax falls from 28% to 26% (applies broadly to stand alone companies with taxable profits of £1.5m or more).

3. R&D tax credits increased from 75p enhancement for every qualifying £1 spent to £1 enhancement. If you haven’t considered whether R&D tax credits apply to your business it is well worth considering now.

Budget 2011 wishes for fast growth digital and tech companies

With George Osborne promising an “unashamedly pro-growth, pro-enterprise and pro-aspiration” Budget tomorrow at 12.30pm, I am looking forward to hearing these words turn into solid, workable solutions for UK entrepreneurs.

Giving Budget predictions is almost as much fun as delving into the actual Budget announcements afterward so please allow me to indulge myself for just two minutes!

Here are the tax changes I would like to hear announced tomorrow:

  1. An increase in the enhanced R&D tax credit deduction from 175% to 200%. I’ve seen so much benefit brought to hi-tech companies from the UK R&D tax incentives but I still see a ‘brain-drain’ in talented technical or scientific entrepreneurs and workers leaving the UK to build businesses where more attractive tax breaks are on offer. Dyson has called for similar changes and we should act now to encourage and retain these export-rich companies.
  2. Introduction of specific tax reliefs for video-game companies. TIGA has been calling for such changes for a while and despite squeaks of support from the previous Chancellor, these plans got shelved by the Coalition government. Canada, South Korea and France are busy supporting their games developer industry so we should likewise support our £1bn UK videogames industry.
  3. A reduction in the 5% shareholding requirement in order for entrepreneur’s relief to be available. Company employees are rarely offered the opportunity to acquire shareholdings of 5%+ let alone have the financial capacity to fund share acquisitions of this quantum so it seems harsh for them to be taxed at a likely 28% tax rate whilst those with a small percentage more could get down to a tax rate of just 10%.
  4. A change in the EMI rules to allow for the 12 month shareholding clock to start ticking from the date of grant of the option – in the same way as the old taper relief rules allowed for the clock to start ticking from the date of grant – for the purposes of entrepreneur’s relief.
  5. Relaxation of the Enterprise Investment Scheme (EIS) rules to allow income tax relief for loans to smaller companies given that accessing lending from banks continues to be difficult – especially for early stage start up companies.
  6. Introduction of the ‘patent box’ for intellectual property income – other EU countries already offer this tax incentive. We need it sooner rather than later.
  7. Enterprise zones to encourage clusters of hi-tech businesses. Mini-Silicon-Valleys with tax breaks for qualifying companies operating within the EZs.

So these are my starter for 7. What have I missed? What measures, incentives or changes would benefit your business?

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Tinkering with tax simplification

Over 1,000 tax incentives have been identified and collated as part of the first stage of the Office of Tax Simplification work – tax advisers across the UK nod wearily! The next step is to review which tax incentives can be eliminated to ‘simplify’ UK tax. Target date for the first review is the next Budget scheduled for 23 March 2011.

I’m in two minds about this – on the one hand, there is little doubt that UK tax legislation has got way out of hand in terms of complexity (for many accountants lets alone business owners!). On the other, there are many targeted tax incentives which appear to have worked well to promote future growth areas e.g. R&D tax credits and the forthcoming ‘patent box’ (promising lower rates of tax) encourage innovation and enhanced capital allowances encourage investment in greener plant and machinery. There are plenty of other targeted tax incentives aimed at putting our economy on a firmer footing for the longer term future. Look at the Dyson Report on Making Britain a Hi-Tech Exporter and the recent Blueprint for Technology report for further support for targeted tax incentives.

Taxation can be effectively used as a carrot to incentivise investment (both cash and more importantly entrepreneurial zeal) in key growth areas, such as intellectual property-rich digital, tech and creative industries; those businesses and sectors that should provide longer term prospects for a healthy UK and global export economy. So why tinker?

Having said that, the relatively recent announcement to provide new start-ups with a holiday from National Insurance Contributions sounds well placed and simple enough – until you look at the detail (and this is just a summary of the detail!).

Overall, I am concerned that putting an axe to scores of these targeted tax incentives in the name of ‘simplification’ could have far-reaching and painful longer term repercussions for the UK economy. Yet we do need to plot a way through the streams of red-tape and bureacracy facing businesses so things must change.

Welcome your views.

Future of R&D Tax Credits

I was asked by a client yesterday whether I thought the UK R&D tax credit system would be around for the foreseeable future?

I answered “Yes”. Here’s a summary of my current thinking:

  • James Dyson‘s Ingenious Britain Report, as commissioned pre-election by the Conservative party into re-energising the British economy, gave the UK R&D tax credit system a whole-hearted thumbs-up – in fact, he recommended that this valuable tax incentive should be further enhanced for innovative high tech UK small companies;
  • The Tories pledged to push forward with a planned review of the taxation of intellectual property this Autumn. The Coalition government is keen to make the UK tax regime one of the most competitive in the G20 and to do so demands a well structured and favourable tax framework for intellectual property – otherwise big multi-nationals look to move their prized assets i.e. their intellectual property (IP) to a more favourable tax jurisdiction and worse, our home-grown talent (- export value – jobs) can be tempted to follow suit;
  • The Autumn review of IP tax is also expected press forward on plans to introduce a new patent box to tax income derived from intellectual property at a lower corporation tax rate – a tax incentive already enjoyed by our Dutch neighbours for example, so it is good to see that UK resident companies should enjoy similar tax benefits in the near future;
  • Generally there appears to be a growing understanding and acceptance (echoed from all political parties: from Alistair Darling to George Osborne to Vince Cable) that the most viable opportunity for rebuilding a long-term sustainable UK economy is to invest in building first class hi-tech innovative and intellectual property rich companies that can export their valuable know-how globally. A recent Nesta report on Rebalancing the UK economy is well worth a read in reaffirming this perspective. In essence: we don’t necessarily have to make the stuff but we can develop the ideas, know-how and proprietary IP for global manufacturers, distributors and retailers to license and sell!

On the negative side:

  • there was a momentary concern in the final stages of the election that the Conservatives would drop the R&D tax regime if elected when they pledged to reduce the headline corporation tax rate and “simplify the corporation tax regime” – could this have meant the death of the R&D tax scheme and other valuable incentives such as capital allowances? (although this proved not to be the case in the Emergency Budget).
  • The Coalition government also put a stop to proposals to introduce a video games tax relief which appears at odds with a perceived overarching aim to focus entrepreneurs on building IP rich digital and technology businesses.

So there have been some wobbles but fingers crossed these are isolated lapses (as a side-note I really hope the gaming tax relief proposals get back on the cards very soon).

What are your thoughts on the future of UK Research and Development tax credits?

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7 tax incentives for UK digital & technology startups

HOT OFF THE PRESS: We’ve just launched a brand new online course that shows you exactly how to complete and file your SEIS / EIS advance assurance application with HMRC. We walk you through every stage of filling out the form plus share some additional resources to help ensure a smoother passage through HMRC. Access it by clicking here. [Use the code: SEISAA2017 to get 50% off in January]

Having taken the risk and side-stepped the typical job route to become a tech entrepreneur and wealth-creator, its a good job that there are still some tempting UK tax incentives out there to support you.

Here are just 7 tax ideas or tips that you should be thinking about for your digital technology start-up:

  1. Entrepreneur’s Relief – if you hold 5% or more of the shares in your startup for 12 months and work as an officer /  director or employee, then when you come to sell the shares your effective tax rate will be just 10% on the gain. This is limited to the first £10m of gain over your lifetime . Sure beats an income tax top rate of 45%! Make sure you take this into account when setting up your company to ensure founders (and key employees) maximise this essential tax relief. You’d be gutted if you unwittingly held just 4% of the shares!
  2. R&D tax credits – get rewarded by the tax man for innovating in your sector by claiming this lucrative tax relief. Many entrepreneurs mistakenly believe that this tax incentive relates solely to industries with scientists wearing white lab coats but this couldn’t be further from the truth. This relief applies across industries – I have enjoyed particular success in the tech sector, for example, I have secured a £250k tax refund for a tech startup that had been (wrongly) advised by its accountants that it wouldn’t qualify for this relief! Most repayments are processed by HMRC within 30 days of a claim and you only have 2 years to make a claim before you’re time-barred. Don’t leave this cash on the table.
  3. Enterprise Investment Scheme – angel investors and private individuals are incentivised to invest in (perceived) higher risk investments like early stage start-up companies with tax breaks like the Enterprise Investment Scheme (or EIS as its more commonly called). Now is not the time for the exact detail suffice to say that many tech or digital startups would fall within the qualifying criteria thereby allowing smart investors to reclaim 30% income tax relief subject to certain limits. Just be aware for now that this is out there to tempt investors. [Update: Seed Enterprise Investment Scheme (SEIS) introduced since this post]
  4. Temporary National Insurance Holiday – for new businesses there is a recently announced temporary NI holiday for the first 10 employees limited to £5,000 per employee or £50,000 overall. The scheme officially kicks off in September 2010 however there should be relief for businesses started post 22 June 2010. This relief is location specific with most of the South East barred so you need to check qualifying locations. Startups across the North will qualify so now is a good time to start building your team.[Update: Now gone – there is an Employer’s NIC £3,000 annual allowance at the time of writing Jan 2017]
  5. Get paid at mouthwatering tax rates compared to most employees – once you get past the pre-revenue stage and start making profits, shareholders of small companies have the flexibility to structure their remuneration package to optimise take-home pay. Why pay up over 20%, 40% or even 45% income tax and incur huge National Insurance costs on employee salaries when you can pay yourself a combination of a small salary, dividends (and pension contributions) which, if carefully managed, can result in £nil income tax or NI for c£40k of remuneration. [Update: Dividend tax rule changes since 6 April 2016 reduce benefits]
  6. Get 100% tax relief on your new equipment – so you need to invest in new Macbooks, laptops, servers and other gadgets for your business. You can claim 100% tax writing down allowances (‘Annual Investment Allowance‘) against profits on your ‘first’ £200,000 (!) of capital expenditure each year [note: this relief has bounced around in recent years since; be wary of timing – it is £200,000 at the time of this update (Jan 2017)]
  7. Patent innovation box – coming soon (allegedly) will be a ‘patent box’ which will allow income or profits on registered patents to attract lower company tax rates of c10% (as opposed to a current lowest corporation tax rate of 20%.

If you’d like to discuss how any of these tax incentives could be applied in your business, please drop me a line via the contact page or you can find professional specialist advice and help at ip tax solutions. Happy to discuss.

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