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R&D Tax Relief

R&D tax relief for SMEs

R&D tax relief for SMEs
Leo French

By Leo French

11 Apr 2024

Contents

Introduction

R&D tax relief is the government’s way of encouraging businesses to invest in innovation. The idea is to reward companies for experimenting, researching, and achieving breakthroughs in science or technology. This can result in better products and services being brought to the market – boosting the UK economy.  

The scheme itself, however, is complex and can be challenging to understand. HMRC’s definition of R&D is subjective in nature and there have been numerous rule changes announced over the past few years.  

R&D Tax incentives can be particularly valuable for SMEs who invest in regular Research and Development projects. However, most SMEs don’t understand what types of activities and expenditure can qualify, the benefits of using the scheme, and how to make a claim.  

This article aims to fix that. We’ll explain everything your SME needs to know about R&D tax credits in the UK.  

Let’s get stuck in. 

First, what is R&D tax relief? 

R&D tax relief lets you claim a corporation tax deduction or a cash payment if you spend money on innovation-related projects. 

If you are in profit, the scheme lets you claim an extra 86% from qualifying costs when calculating expenses for a total taxable profit reduction of 186%.  

For example, suppose your gross profit is £200,000, and you spend £100,000 on R&D. You can subtract an additional £86,000 from this figure (even after deducting the 100% of your R&D expenses) for a taxable income of just £114,000. 

You can also claim a payable tax credit if your firm claims relief while making a loss, with credit paid up to 10% of that loss. 

For example, suppose your company is a startup and loses £100,000 in the first year. If you spend on R&D, you can receive up to £10,000 in cash back from the government – 10% of the loss.  

 Dive deeper: Your essential guide to R&D tax credits

And what constitutes an SME for R&D purposes? 

To qualify as an SME for R&D tax relief, you must have:  

  • Fewer than 500 staff 
  • A turnover under €100 million 

You must also include any linked enterprises in your totals. The government says there is a link between your firm and another if:  

  • It holds over 50% voting rights or vice versa 
  • It has controlling rights or vice versa 
  • Or a third party controls both your firm and the other enterprise 

Other exclusion rules also apply. For instance: 

  • You cannot claim R&D tax relief if your firm already receives State Aid over €7.5 million for the R&D expenditure for which you claim relief. 
  • The project has been subsidised in some other way, for example by a grant, but you may be able to claim on the part that is not subsidised. 
  • You have received any other State Aid (excluding the SME tax relief) for the project. 

Note: If you’re wondering why the financial thresholds are in Euro, and not GBP, it’s because the UK adapted the rules from the EU. As a bonus, it makes it easier for businesses operating both within the UK and in EU countries to understand their eligibility.

Benefits of R&D credits for SMEs 

Reduce Corporation Tax Bills 

Rules let SMEs subtract more than the cost of R&D from corporation tax bills. Tax rates are substantially lower for participating firms than for those doing Research and Development but not taking advantage of the scheme. 

For example, an SME spending £50,000 qualifying R&D and making a profit of £10,000 without tax credits will pay the 19% small profits rate, implying a corporation tax liability of £1,900. However, an identical company that claims R&D tax relief will reduce their tax bill to zero (since 86% of £50,000 is greater than the taxable profits).  

Team growth 

Enhancing profitability through R&D tax credits makes it more viable for participating firms to generate employment. The scheme is designed to incentivise companies to re-invest in the R&D teams. 

Offset Losses 

Finally, R&D tax credit rules also lessen losses. Companies spending on qualifying projects can receive cash payments of up to 10% of their losses in 2023-24. New firms can use the rules to improve investor relations and reduce cash burn, whilst established players can get relief during periods of intense technological disruption. 

What can SMEs claim for? 

Numerous costs qualify for R&D tax credits. These include: 

  • Staffing costs: including gross salary, employer’s NIC and pension contributions, overtime/bonuses and reimbursed staff expenses 
  • Consumable and materials items: such as stationery, computer peripherals, R&D prototype materials, laboratory consumables and utility costs (gas, electricity, water) 
  • Software costs* 
  • Subcontractors or Externally Provided Workers** at 65% for unconnected parties (restrictions apply for the RDEC scheme) 
  • Independent research (RDEC scheme only) 

However, some costs do not qualify. For example, you cannot use land expenses or capital costs under the R&D tax relief scheme. The government also disqualifies expenditure in obtaining intellectual property rights (i.e. patents and trademarks) or rents paid to owners of research and development facilities.

How do SMEs make an R&D tax credit claim?  

SMEs can make an R&D tax credit claim using the following step-by-step process:  

Step 1: Check the pre-claim requirements  

HMRC applies different rules depending on the year for which you are claiming R&D tax credits.  

If you want to claim credits for accounting periods before 1 April 2023, you must submit a claim pre-notification to HMRC. This form tells tax officials you intend to make a claim.  

You must submit additional information to claim R&D relief after 8 August 2023. HRMC introduced new requirements to reduce fraud. 

Step 2: Claim on your company tax return 

Once you complete the pre-claim requirements, you can claim on your company tax return. Do this by:  

  • Completing the iXBRL computations file 
  • Check boxes 656 and 657 to indicate you have completed the relevant pre-claim requirements (depending on your claim) 

Step 3: Complete the relevant supplementary forms 

Finally, you need to complete the relevant supplemental relief forms. The CT600L form helps HMRC prevent fraud by providing the tax authority added information related to your R&D project.  

You can also apply for R&D Expenditure Credit (RDEC) if you are a small business but don’t qualify for the relief described above.  

How Gerald Edelman can help

Hopefully, with the help of this guide, you now have a stronger understanding of how the R&D tax credit system works and your SME is in a better position to benefit. 

As we look ahead, the strategic use of R&D tax credits will continue to play a pivotal role in enabling SMEs across the UK to push the boundaries of innovation, driving growth within their industries and the broader economy. More practically, there are huge tax efficiencies to consider. 

Unfortunately, the rules surrounding these reliefs and the application process can be complicated. That’s why it’s always worth partnering with an expert. 

Our team of R&D advisers can help with every stage of your application. Get in touch today to organise a free consultation.  

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