Where R&D is conducted by a UK company, the expenditures are deductible as a regular revenue expenditure, and also generate substantial tax credits. These tax incentives can represent from 8.4% of the expenditure, to 24.5% in favorable circumstances. Often these incentives are refundable (even if no taxes have been paid), and thus offer a critical source of funding for many companies.

The large variability in the tax incentive rates noted above arises from a number of factors. In essence, these factors all relate to policy decisions by tax authorities to provide higher incentives for smaller companies.

The rate at which a specific company earns R&D tax incentives is calculated based primarily on turnover, fixed assets and staff numbers.

The above three attributes taken into conjunction with those same attributes as applied to group companies. And, for SMEs, the presence of trading losses.

The product of the qualifying expenditures and the appropriate tax credit rate, governs the amount of the tax incentive. The mechanics of the process are a bit confusing at first, but not difficult to understand. Numerous rules have evolved over the short history of the program. A summary of the incentives for qualifying expenditures is given in the table presented below.

Incentives are earned at an effective rate of either 8.4%, 21% or 24.5% of the expenditures. The rate depends on the company’s economic power.

Notes

An SME can deduct 175% of expenditures incurred in carrying on R&D. In order to claim the enhanced deduction it must either incur R&D expenditures on its own behalf, or subcontract R&D work to someone else. An SME that does not earn a profit, and therefore is not able to obtain immediate benefit of the 175% deduction, can surrender its “surrenderable loss” in return for a cash refund. The refund is made at a rate of up to 24% of eligible R&D expenditures incurred. The cash refund (payable R&D tax credit) is limited to the amount of the company’s PAYE and NIC liabilities paid for payment periods ending in the relevant accounting period.

Certain SMEs are restricted from claiming this relief. In order to qualify for these incentives the SME must be entitled to ownership rights in the resulting intellectual property. Any funding of an R&D project by another person or state reduces or eliminates the amount eligible for these incentives.

An SME is a company with fewer than 500 employees and either has an annual turnover of less than EUR 100 million or a balance sheet total (total fixed and current assets, not net assets) of less than EUR 86 million. An SME cannot be a member of a large group.

1. The amount of an SME’s surrenderable loss is equal to the lessor of 175% of qualified R&D expenditures and the company’s current year trading loss after setoffs.
2. The 24.5% credit available to SMEs is a refundable (payable) credit. SME’s that do not claim the 24.5% refundable tax credit and Large Corporations are eligible for an additional deduction equal to 175% and 130% of qualified R&D expenditures respectively. At a corporate tax rate of 28% these amount to effective tax credits of 21% and 8.4% respectively. (75 times 28% and 30% times 28%)
3. SMEs can claim for expenditures on R&D subcontracted to others. A Large Company can only claim for expenditures on R&D it carries out, unless it subcontracts R&D to certain qualifying bodies, individuals or partnerships of individuals.
4. An SME cannot claim for contributions to independent research. A Large Company can claim for contributions to independent research.
5. An SME claim is subject to possible reduction if the R&D project is subsidised or a grant is received is respect of it. There is no similar reduction applicable to Large Corporations.
6. An SME must own the intellectual property arising out of R&D in order to claim the R&D incentives. A Large Company need not own the intellectual property to claim the incentives.

The Strategy

In setting up corporate structures be aware of SME status.

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