R&D Tax Credit Calculations Explained
The problem is that claiming these credits can be challenging and complicated because there's a wealth of information available and HMRC has set out very specific requirements that companies need to comply with.
Fortunately, we're here to help, and with this guide, we’ll delve into these credits in more detail and show you an example or two of an R&D Tax Credit Calculation.
What Are R&D Tax Credits?
To drive innovation in various industries, the government incentivises the most innovative companies. So, companies that push the bounds of creativity, innovation and solve problems can claim tax credits either as a cash return or as a reduction in Corporation Tax. Once companies claim these credits, they can invest them back into the business in the next financial year.
These credits are known as Research and Development or R&D Tax Credits.
Who Can Claim?
Basically, any company can claim R&D Tax Credits. So, irrespective of whether you’re a start-up, medium, or large company, you might be able to claim R&D Tax Credits. In fact, to qualify for these tax savings you only need to prove that:
- You’re a Limited UK Company currently paying Corporation Tax.
- You’ve carried out qualifying R&D activities. The criteria for an activity to qualify is relatively broad with one of the main requirements being that you’re attempting to resolve scientific or technological uncertainties.
- You’ve invested money in these activities.
Keep in mind that, although you could qualify, there are factors that affect the value of the R&D Tax Credit claim. These factors are:
- The size of your company. So, whether you’re, for instance, an SME or a large company.
- The amount of Corporation Tax you pay.
- Whether you’re making a profit or a loss.
The factors above will determine what scheme you qualify for. Here, there are two schemes, the Research and Development Expenditure Credit (RDEC) scheme and the SME scheme.
When you qualify as an SME, you qualify for credits in terms of the SME scheme. To qualify as an SME, you must employ fewer than 500 employees. In addition, your annual turnover should be less than £86 million or your balance sheet should be less than £74 million.
When you qualify as an SME for purposes of the scheme, you’ll be entitled to claim up to 33% of your R&D spend against your Corporation Tax or, in some cases, as a cash return.
It’s important to keep in mind that several factors can affect your status as an SME and, therefore, your ability to claim in terms of the scheme. For example, when you receive a grant, subsidy, or state aid it could change your status to that of a large company.
Companies can also qualify as large companies outright when their number of employees or turnover exceeds the thresholds mentioned above. Also, companies can qualify as large companies even when they have fewer than 500 employees, but their turnover or balance exceeds the thresholds.
Irrespective of how you qualify as a large company, if you do, you’ll be able to claim R&D Tax Credits in terms of the RDEC scheme. Here, you’ll be able to claim up to 13% of the money you invested in research and development against your Corporation Tax or, as is the case with the SME scheme, as a cash return.
What Can You Claim?
Now that you know what R&D Tax Credits are and who can claim them, you’re probably wondering what you can claim. Let’s take a look.
For any staff that work directly on an R&D project, you can claim a proportion of their:
- Class 1 National Insurance contributions
- Pension fund contributions.
You can also claim for administrative or support staff that directly supports a project. So, for example, you’ll be able to claim for human resources who recruit and hire staff to work on the project. You’re also entitled to claim up to 65% of relevant payments made to an external agency that provides staff for a project. These staff typically include agency staff, contractors, or freelancers.
Keep in mind, though, that you won’t be able to claim for any clerical or maintenance work that staff would have done anyway. A perfect example here would be payroll management.
To calculate the employee costs that you can claim for, you'll need to add up the total costs for every employee who worked on the project. You'll then multiply this amount by the portion of time the specific employee spent on the project during the year for which you're claiming.
So, for example, if the total costs for a specific employee worked on the project is £50,000 and they've spent 40% of their time working on the project, you’ll be able to claim £20,000. You'll then need to repeat this calculation for every employee that worked on the R&D project.
You’ll follow a similar process to calculate the amount you're able to claim for staff provided by external agencies. Here, however, you’ll identify the time spent by the workers on the project and multiply that by 65% to calculate the amount you're able to claim.
It often happens that you need to outsource work to another company at an agreed amount. If you do this during an R&D project, you can claim up to 65% of these costs.
It’s important to remember that you’ll only be able to claim these costs in terms of the SME scheme. Under RDEC, subcontractor expenses can’t be claimed unless it’s directly undertaken by:
- a charity.
- a higher education institute
- a scientific research organisation
- a health service body
- an individual or partnership of individuals.
When you qualify as an SME under the SME scheme, you're able to claim software licence fees paid for research and development. You're also able to claim a reasonable share of the costs for software partly used in your research and development activities.
Under both the SME and RDEC schemes, you're able to claim for the relevant proportion of consumable items that you used up in your R&D activities. These consumable items include, for example:
- materials, and
Although these consumables typically include materials like water, fuel, electricity consumption, and other materials used in the construction of prototypes. It’s important to note that you're not able to claim for materials that were not used up or materials that were incorporated into a product you sold to a client.
Clinical Trials Volunteers
When you claim in terms of the SME scheme, you can claim payments made to volunteers who took part in clinical trials. However, keep in mind, that this is only possible for research and development projects in the pharmaceutical industry.
What Can’t You Claim?
Unfortunately, there are some items that you're unable to claim for in respect of both the SMB and the RDEC schemes. These items are:
- the production and distribution of goods and services.
- capital expenditure.
- the cost of land.
- the cost of patents and trademarks that you used during your research and development.
- rent or rates paid during the period.
R&D Tax Credit Calculation Made Easy
Now that you know what the R&D Tax Credit is, whether you can claim and what you can claim for, let’s take a look at R&D Tax Credit Calculation in more detail.
As a profit-making SME, you claim your R&D tax credit by enhancing your expenditure and entering your enhanced expenditure into your tax return form.
To calculate this enhanced expenditure, you’ll need to:
- Calculate the costs that you can directly attribute to research and development. During this step, you’ll also reduce any relevant subcontractor or external staff provider costs by 35% to 65% of the original costs.
- You can then add all the aforesaid costs together which will then be your qualifying expenditure.
- You’ll then multiply your qualifying expenditure by 130% to calculate the additional deduction that you'll use in your tax calculations. During this step, you’ll increase your R&D expense for the year and, as a result, reduce your taxable profit.
- You can then add this amount to your original expenditure that you'll use in your tax return. When you deduct the new Corporation Tax amount from the original Corporation Tax amount, you’ll see the saving as a result of the R&D Tax Credit.
To best illustrate the aforesaid process, let’s look at an example. Let's say, for instance, that you're an SME for purposes of the SME scheme and you made a profit of £500,000 for the financial year. Now, let’s say you already deducted a qualifying expenditure of £100,000. As a result, your Corporation Tax will be £95,000.
Now, as appears from the above, you've carried out R&D activities and you've calculated the qualifying expenditure to be £100,000. You’ll therefore multiply this amount by 130% and deduct the result from your original profit. In other words, your R&D expenditure will now be £130,000 and your revised profit will be £370,000.
Based on your revised profit, your Corporation Tax will now be £70,300. When you deduct this amount from your original Corporation Tax amount, it gives you a saving of £24,700.
When you qualify as an SME in terms of the SME scheme, but you're making a loss instead of a profit, the R&D Tax Credit Calculation is the same as the procedure set out above. So:
- You’ll calculate your quantifying expenditure.
- Just like before, you'll then multiply your qualifying expenditure by 130%. The effect of this is that you increase your losses.
- Once calculated, you'll add this amount to your original expenditure to get your enhanced expenditure.
The difference here is that you have two options in respect of your losses. For one, you can cash in or surrender your losses. This amount is calculated as your revised loss for the year or 230% of your qualifying expenses, whichever is lower and is then surrendered to HMRC for a cash tax credit calculated at a rate of 14.5%.
Your other option is to carry forward these losses to the next financial year. When doing so, you'll be able to set off these losses against future taxable profit. Once again, to illustrate the above process, we'll use an example.
Let's say, for instance, that you qualify as an SME in terms of the SME scheme, and you've made a loss of £500,000 for the financial year. Also, you've already recorded a qualifying expenditure of £100,000.
You’ll then multiply your qualifying expenditure by 130% to calculate your enhanced expenditure. As a result, your total loss for the year will now be £630,000. Because this amount is higher than 230% of your qualifying expenses, you’ll then be able to surrender £230,000 to HMRC. The total amount you would therefore receive as a tax credit of £33,350.
When you don't qualify as an SME, but rather as a large company and, therefore, eligible to claim an R&D Tax Credit in terms of the RDEC scheme, you’ll follow the same procedure above to calculate your qualifying expenses.
Once you've calculated your qualifying expenses, you'll then multiply this amount by 13% to get your expenditure credit. You'll then be able to use this amount in your tax return.
What Can Influence R&D Tax Claims?
Several factors can affect your R&D Tax Credit claim, especially if you’re an SME for purposes of the SME scheme. Let's look at these factors in more detail.
Connected and Partner Companies
As stated before, to qualify as an SME for the SME scheme, you must employ fewer than 500 employees and your annual turnover or balance sheet must be lower than the thresholds.
In respect of connected companies, your company is connected to another if your company holds over 50% of the voting rights in the other company or the other company holds over 50% of the voting rights in your company. In either case,
the staff, turnover, and balance sheets of these companies should be included in your totals.
In respect of partner companies, you have a partner company if another company holds over 25% of your voting rights or capital or you hold over 25% of the voting rights or capital in the other company.
If this is the case, you need to include a proportion of the other company's staff, turnover, or balance sheets in your total. This proportion is based on the percentage of voting rights and capital that connects you with the other company.
Subcontracted Research and Development
As mentioned before, you're entitled to claim R&D Tax Credits of 65% of your expenditure on subcontractors used for research and development. It is, however, important to note that different rules apply, and the definition of subcontracting is very specific.
Also, when you want to claim in terms of the RDEC scheme, you'll only be able to claim for subcontractor expenses when the subcontractor falls within one of the categories mentioned above.
Grants and Subsidies
As mentioned before, when you receive grants or subsidies to do research and development, it can influence your ability to claim R&D Tax Credits. For example, it could mean that you no longer qualify to claim in terms of the SME scheme. In such a case, it could still be possible to qualify for the RDEC scheme, but your benefit will be lower.
The Bottom Line
When you're a company at the forefront of innovation, R&D Tax Credits can be a perfect way to lower your tax burden and increase your profits. The problem is that these claims can be confusing and complicated, especially if you don't have sufficient experience with HMRC and their requirements.
Fortunately, we're here to help and with over £30 million of claims processed and a world-class technical team, we've got the experience you need to make claiming R&D Tax Credits easy and efficient. To find out more about our range of services and how we can help you maximise your refund, why not contact us to speak to an expert.
Hopefully, this post helped illustrate the ins and outs of R&D Tax Credits. To provide you with more information, we've compiled a list of common questions many companies have.
How to qualify for R&D Tax Credit?
Basically, any company can qualify for an R&D Tax Credit. It only needs to prove that it’s a Limited UK Company currently paying Corporation Tax, that it has carried out qualifying R&D activities, and that it has invested money in these activities.
How to claim R&D Tax Credit?
Irrespective of whether you claim an R&D Tax Credit in terms of the SME scheme or the RDEC scheme, you’ll calculate your qualifying expenditure as set out above. You'll then enter this expenditure or enhanced expenditure, depending on the case, into the full Company Tax Return form.
It's important to keep in mind that, in both instances, you can claim for R&D Tax relief up to two years after the end of the accounting period during which the expenses were incurred. It's also important to note that you'll need to support your claim for R&D Tax Credits in both instances.
How to record R&D Tax Credit
Accounting for an R&D Tax Credit is relatively straightforward. For SMEs, the R&D Tax Credit is not taxable income and it’s a below-the-line benefit that will be shown in your income statement either as a tax reduction or a credit. In turn, for RDEC claims, the Tax Credit can be accounted for above the line and has an impact on profit before taxation.