Research and development tax relief is a useful tool to help startups claim cash or cut their tax bill.
Startups that carry out research and development (R&D) may be able claim money off their tax bill or even get cash back from the UK Government – and if you don’t think your business conducts R&D, then it may pay to think again.
Tax credits to reward innovation
R&D tax relief was introduced in 2000. The scheme has been expanded and adjusted over the years but, at its heart, it still rewards companies that use their intellectual property (IP) to innovate and increase UK productivity.
There are two schemes: small and medium-sized enterprises (SME) R&D relief for businesses that have fewer than 500 members of staff and which turn over less than €100 million (£90m) or have less than €86m (£78m) on their balance sheet; and the R&D expenditure credit (RDEC), which replaced the large company scheme.
IP projects that count as R&D include creating a product, process or service, or improving an existing one. The work must relate to the company’s trade – either its existing business, or one that it intends to start based on the results of the project.
A wide range of industries and technologies
“Growing tomatoes using lasers – that goes down as one of the more unusual tax credit claims,” remembers Chris Anderson, UK sales director at consultancy firm ABGI, which helps companies to apply for R&D tax relief. As well as listing digital technology, oil and gas, and engineering firms amongst its clients, the firm also works with startups and smaller players in the industries’ supply chains, such as businesses providing parts to aerospace giant Rolls-Royce.
“Food is an interesting one – we saw a large increase in R&D around the time the sugar tax was being introduced because companies wanted to make their products taste the same, but with less sugar and fewer additives. We’re now seeing a similar situation with the ‘fat tax’, with a lot of companies investing in R&D to make their products healthier.”
R&D tax credit criteria
Companies that apply for tax relief need to explain how their project:
- Looked for an advance in science and technology
- Had to overcome uncertainty
- Offered a solution that could not be easily reached
The two schemes’ definitions of science and technology don’t include social sciences – like economics – or theoretical sciences, such as pure mathematics. Yet they do allow companies to claim tax relief even if their projects are unsuccessful.
An advance in the field must cover the whole sector and not just the company itself. Applicants have to be able to explain why a professional could not work out easily how the advance would work and need to be able to show there was uncertainty in the outcome and explain how that uncertainty was overcome.
“We find it’s around those technical elements that clients fall foul of claims being rejected or being investigated by HM Revenue & Customs (HMRC),” explains Anderson. “About 40% of the market every year is still first-time claimants, so it’s still a growing market.”
Billions claimed in R&D tax relief
The SME R&D relief allows companies to deduct an extra 130% of their qualifying costs from their full-year profit, as well as the normal 100% deduction, to make a total 230% deduction. If the company is making a loss then it can claim a tax credit worth up to 14.5% of the surrenderable loss – meaning it can get cash from the taxman. (Explanation of terms from HMRC here).
The RDEC also comes in the form of a tax credit and was worth 11% of the applicant’s qualifying R&D expenditure up until 31 December 2017, before being increased to 12% between 1 January 2018 and 31 March 2020, and then raised again to 13% from 1 April 2020.
In 2016-17, the last full year for which figures are available, the total number of claims for R&D tax relief rose by 20% year-on-year to 52,335, driven by claims from SMEs climbing by 22% to 45,045. The total amount claimed increased by 14% to £4.4 billion.
Between 2001 and 2017, more than 300,000 claims were filed with HMRC and £26.9 billion in tax relief was claimed. As startups look for a shot in the arm to help fund their IP, R&D tax relief is an avenue that’s clearly worth exploring.