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Research & Development Tax Credits

This articles gives an overview of the guidance regarding the making of a Research and Development (R&D) Tax Credits claim. R&D Tax Credits are a valuable relief available to companies operating in the field of R&D but due to the background work required to put together a successful claim many companies overlook this valuable relief. The aim of this article is to set out the main factors that determine whether or not expenditure qualifies as R&D expenditure and how to go about putting a claim together.

Research & Development, previously named Scientific Research Allowance, permits revenue spending on scientific research by companies, either incurred directly by the company or indirectly through subcontracted research work to be relieved against profits.
R&D Tax Relief can work in one of two ways, either through an increase in the relief available for qualifying spending or through a cash payment known as an R&D Tax Credit if the company reports a loss during a period in which R&D spending was incurred. From 1 April 2002, large companies also qualify for R&D Tax Relief, albeit at a reduced rate of 130% in comparison to the 175% relief available to small or medium companies (SMEs).

Who can claim R&D tax credits?
Only companies can claim R&D Tax Credits. There are two schemes depending on whether the R&D is carried out by

  • a small or medium sized company (SME), or
  • any company other than a SME (a large company) for accounting periods ending on or after 1 April 2002.

What is a SME?
A SME is defined in the legislation as a company which, together with any other company in which it holds more than 25% of the voting rights or capital, has:-
  • Less than 500 employees (250 pre 01/08/08)
  • An annual turnover of not more than €100 million (€50m before 01/08/08)
  • An annual balance sheet total of more than €86 million (€43m before 01/08/08)
  • A large company is defined as any company that is not an SME.

    Qualifying conditions?
    For R &D relief to be available the total R&D expenditure must not be less than £10,000 in a 12 month accounting period. If your accounting period is longer or shorter than 12 months the £10,000 is reduced or increased proportionately.
    R &D expenditure does not have to have been incurred in the UK to qualify for the enhanced tax relief.

    What is R &D for tax purposes?
    The definition of R&D can be found in the DTI Guidelines. These guidelines essentially state that a project will qualify as R&D for tax purposes if it seeks to:-

    • extend overall knowledge or capability in a field of science or technology (i.e. overall knowledge in the field and not solely the company's own level of knowledge or capability); or
    • create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or
    • make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or
    • use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way (e.g. a product which has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner)

    Qualifying Expenditure
    Expenditure incurred by a SME will qualify for R&D relief if it fulfils the following conditions:-

    • it is attributable to relevant R & D
    • it is not capital in nature
    • any intellectual property created that is attributable to the R&D expenditure must be vested in the company incurring the expenditure
    • The company has not incurred the expenditure as a sub-contractor
    • The expenditure is not subsidised
    • The expenditure is incurred in relation to staffing costs or consumables.

    Expenditure incurred by a large company will qualify for R&D relief if it fulfils the following additional conditions:-

    • The expenditure must be in relation to R&D carried out by the company either for itself or as a subcontractor.
    • If the expenditure relates to work contracted to it, the contractor must be a large company or an entity that is not in the course of a trade or profession.

    In most cases expenditure on R&D will only be incurred where there is a commercial reason for the company to undertake the R&D. Predictably therefore, R&D ex pen diture will only qualify for R&D relief if the company intends to commercially exploit the results of the R&D.

    Eligible Expenditure?
    The following costs are eligible for the enhanced R&D Tax Relief:-

    • Staffing costs for R&D employees
    • The costs of paying an external staff provider for R&D staff
    • Materials, water, fuel and power for R&D
    • Software used directly in the R&D
    • Subcontracting out R&D activities.

    To be eligible when they are incurred on activities that directly relate to the resolution of uncertainty of a scientific or technological nature.
    Capital expenditure on R & D will qualify for 100% R&D capital allowances.

    How much can a company claim?
    Claims can only be made for the accounting period in which the qualifying expenditure was incurred.
    The SME scheme allows qualifying companies (see above) to deduct 175% (150% before 01/08/08) of their qualifying expenditure when calculating their profits for tax purposes. Such a claim is made in the company's Corporation Tax Return (CT600). Should the SME have a loss for tax purposes then it can claim up to 24% of the qualifying expenditure as a payable tax credit in return for surrendering the loss created by the R&D relief.
    Large companies
    The large company scheme allows companies that do not qualify for the SME scheme to obtain a 130% (125% before 01/08/08) deduction for their qualifying expenditure when calculating their taxable profits.
    Time Limit
    Any claim for R&D Tax relief must be made within by the first anniversary of the filing date for the accounting period in which the expenditure was incurred.

    How to show the project is genuinely R & D
    When making a claim it is recommended that a brief report is submitted considering the application of the R&D rules to the project for which relief has been claimed (as set out in HMRC's Tool A ). This will enable the HMRC officer reviewing your claim to determine whether or not the R&D expenditure qualifies. For this reason it is often useful to have an early understanding of what is entailed so that records can be kept and processes documented at the time the project is being undertaken. We strongly advise that this approach is taken so that if HMRC question the nature of the expenditure, the answers are readily available.

    Scientific or Technological Advance?
    Rather than focusing on the product, process, material etc that is being developed it is important that you consider what advance is being sought. This is the key issue in an R&D claim and it is vital that you can evidence the fact that a clear advance in the knowledge in your field is being sought. The fact that the result of the project is innovative is not enough to constitute R&D, there has to have been an advance in knowledge or skill that enabled the product to be created or designed.

    Scientific or Technological Uncertainty?
    In order to show that an advance has been made or is being sought it will be necessary to show that, at the outset, there was uncertainty as to whether or not the desired result was feasible. Uncertainty is deemed to exist if the knowledge of whether or not the advance being sought is achievable would not be readily available or deducible to a competent professional working in the field. If the uncertainty can be resolved through short discussions with peers in the field then it does not qualify as a technological uncertainty and is simply a routine uncertainty.

    How were the uncertainties overcome?
    As part of documenting the processes undertaken it is useful if you record the steps you take in attempting to overcome the uncertainties. You should be able to des cribe the processes involved and the investigations and analyses undertaken. The successes and failures of each step and how they contributed to the outcome of the project.

    Was the knowledge readily available to a competent professional?
    In some cases it may be publicly known that others have pursued a certain ‘advance' and have failed to resolve the inherent uncertainties. Alternatively they may have been successful but how they achieved this may not be in the public domain. In either case, it is obvious that the knowledge is not available to a competent professional working in the field.
    Alternatively, if there is little information in the public domain you will need to show that the individuals leading your R&D are competent professionals in the relevant field. Details of their qualifications, background and experience will be useful along with their analysis of why they consider the uncertainties are real scientific or technological uncertainties rather than routine uncertainties (as defined at point 2).
    We have experience in submitting R&D Tax Credit claims and would be happy to assist you in this process. To discuss your company's R&D Claim please contact us.

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