R&D Tax Credits
Everything You Need To Know
One of the UK government’s most impactful schemes for business tax relief is the R&D Tax Credits Scheme.
Since 2000, this scheme has provided support for companies undertaking research and development (R&D) projects.
And yet since 2000, companies have struggled to understand the nuances of the R&D Tax Credits scheme, with many not even trying to claim money they could well be entitled to because of the complexity in doing so.
In this article, we cover exactly what business owners need to know about R&D tax credits, as well as the significant changes to R&D tax credits in the 2023 Autumn budget.
Written by: Sam Hodgson
Last Updated: 12/09/2024
What is the R&D Tax Credits Scheme?
R&D Tax Credits refers to the Research and Development scheme in the UK. Research and development are of extreme importance to the British government and the country as a whole, providing the thrust behind business growth and ongoing improvement.
Without continuous research and development, new products would never come to market, existing products would stagnate, and the UK would fall behind on the world stage.
To this end, the UK government has a range of schemes in place to support businesses venturing forward in this way - of those schemes, the most significant is the Research and Development Tax Credits Scheme.
For two decades, the R&D Tax Credits system has been split into two distinct branches, one for small and medium sized enterprises (SMEs) and a second for larger businesses.
The former is SME R&D Tax Relief, while larger companies utilised the Research and Development Expenditure Credit (RDEC).
When researching the R&D Tax Credits system, you will come across references to these two separate schemes and the different criteria and support each offers.
However, in the Autumn Statement given on 22nd November 2023, the Chancellor of the Exchequer, Jeremy Hunt, outlined major changes for the system, most significantly the merger of SME R&D Tax Relief and the RDEC into one ‘simplified’ structure. This change is important and removes the criteria of company size for all claims from April 2024 onward.
In this guide, we will touch on the two different systems that have been in place for more than twenty years, but with an emphasis on the newer structure in force for 2024 and beyond.
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Who Is the R&D Tax Credits Scheme For?
What is Meant by Research and Development?
Claiming R&D Tax Relief for Prior Accounting Periods
R&D Changes In The Autumn Statement 2023
How Much Tax Relief Are You Eligible For?
Who Is the R&D Tax Credits Scheme For?
The R&D Tax Credits Scheme is designed for limited companies that undertake research and development projects.
It is easy to believe that R&D tax credits are only available for science and tech companies. The term ‘research and development’ may conjure up the idea of scientists in white coats in labs and little else.
While ‘science’ and ‘technology’ are key terms in the definition of R&D for tax purposes, many businesses in the UK engage in R&D projects without thinking of themselves as doing so.
Consider, for example, a confectionary company with chefs who undertake a project to develop and refine recipes to bring new products to market. Research and development aren’t restricted to one industry, even though those form a significant portion of qualifying applicants.
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What is Meant by Research and Development?
The government defines it as ‘R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology’. One of the important terms in that sentence is ‘project’. It is made clear that qualifying R&D must be part of a project to achieve a specific aim, not just work done in the usual way.
This means that if a company sets aside time to improve existing flavours and techniques, the costs of doing so are within the criteria for tax relief. Many of the companies that can take advantage of R&D tax relief are those in rapidly advancing technology fields.
Others include businesses based in the sciences, focused on solving environmental issues, automotive manufacturers, medical advances, and more. The sectors where relevant research and development occurs are far broader than many believe - and there is every chance your business may be among them.
The government's guidelines provide a more in-depth look at what activities qualify for R&D tax relief.
SME R&D Tax Relief, RDEC, and Claiming R&D Tax Relief for Prior Accounting Periods
Until April 2024, the R&D Tax Credits scheme was divided into a scheme for SMEs and another (known as RDEC) for larger corporations.
These two schemes had several key differences, requiring additional expertise and support to make qualifying claims.
While these differences will no longer be relevant after 1st April 2024, the ability for businesses to submit claims for R&D Tax Credits for prior accounting periods mean the older RDEC and SME schemes remain relevant until 2026.
Prior to 1st April 2023, a business could submit a claim for R&D Tax Credits at any time until the first anniversary of the filing due date of the company tax return for the accounting period in which the claim is made. A slight adjustment made in the 2022 Autumn Statement altered this timing definition to become two years from the end of the relevant accounting period. The change is minor and has little real effect on the grace period.
This means businesses have (and will continue to have) two years from the R&D project having incurred costs to claim the relevant tax relief. Claiming for periods before April 2024 must be done using the appropriate SME R&D Tax Relief or RDEC systems.
R&D Changes In The Autumn Statement 2023
The biggest changes to R&D Tax Credits occurred in two consecutive Autumn Statements made by Jeremy Hunt as chancellor. The first, in 2022, significantly tightened the criteria for SME tax relief, arguing that the scheme was suffering from misuse.
One undesirable impact of these changes was a significant drop in the value of the R&D tax credits, which for loss-making SMEs fell (once all factors are taken into account) from an effective 33.35% to a far smaller 18.6%. Break-even SMEs suffered an even greater loss, from 18.85% before 1st April 2023, to 8.6% following.
The following Autumn Statement from 2023 saw another round of changes, most significantly the merging of SMEs' R&D Tax Relief and the RDEC system for larger businesses. This was stated to simplify R&D Tax Relief, making it easier for all.
While the merging of the two schemes will undoubtedly make future applications for R&D Tax Relief more uniform, the scheme's needs make the process still far from simple.
A Simplified Approach
While the government merged the two schemes in 2023 to simplify the scheme, it is far from a one-size-fits-all scheme. Qualifying companies will need to be defined as loss-making, break-even, or profit-making, an important criteria for calculating R&D tax credits.
Loss-making businesses are classified as ‘R&D Intensive’. This is now defined as a company with a qualifying R&D expenditure that is 30% or more of its total expenditure (a change from the previous threshold of 40%). When a business is defined as R&D Intensive, it is eligible for a higher band of tax credits.
While this is a positive change for many, it does put the supposed simplicity of the post-2024 system to question. Despite the recent changes to make the process easier to understand, there are still complexities.
The Numbers: How Much Tax Relief Are You Eligible For?
Is applying for R&D Tax Credits worthwhile? Like any funding, it is important to understand the benefits before investing the time required to make the application.
With R&D Tax Credits, the answer is typically a resounding ‘yes’, as the savings are significant. However, successfully obtaining the relief will require work, and it's often advisable to seek professional advice beyond your standard accountancy firm.
Tax credits work on two levels, depending on whether your company is profit-making or suffering a loss. A third category - those who are breaking even - presents additional complexities. These classifications are essential to establishing your eligibility for tax relief.
Companies Running at a Loss
If your business is making a loss, then in place of tax relief, one of three options will apply:
-
You can carry back the loss to the previous accounting period
-
You can carry the loss forward to offset against future profits
-
You can surrender the taxable losses for a cash credit
Before 2023 (and for SMEs making a claim for this period) the effective tax relief (or cash credit) for non-‘R&D intensive’ businesses works out at 33.35% of the eligible R&D expenditure. However, changes brought about by the treasury in the 2022 Autumn Statement lowered that figure to an effective 18.6% for the 2023 tax year. Further changes in the 2023 Autumn Statement result in an effective 16.2% going forward.
As an example, a loss-making company that does not qualify as ‘R&D intensive’ with four years of eligible R&D at £50,000 per year between 2022/23 to 2025/26 would see the following relief:
Non R&D Intensive Business
|
Tax Year |
Eligible R&D Expenditure |
Effective Relief % |
Tax Relief Value |
|
2022/23 |
£50,000 |
33.35 |
£16,675 |
|
2023/24 |
£50,000 |
18.6 |
£9,300 |
|
2024/25 |
£50,000 |
16.2 |
£8,100 |
|
2025/26 |
£50,000 |
16.2 |
£8,100 |
Those loss-making companies classed as ‘R&D intensive’ (those for whom research and development represents 30% or more of expenditure from April 2024, and 40% or more previously) enjoy a significantly higher rate, which effectively calculates to 26.97% from 2024 onwards. Similar R&D expenditure for a ‘R&D intensive’ company would be as follows:
R&D Intensive Business
|
Tax Year |
Eligible R&D Expenditure |
Effective Relief % |
Tax Relief Value |
|
2022/23 |
£50,000 |
33.35 |
£16,675 |
|
2023/24 |
£50,000 |
26.97 |
£13,485 |
|
2024/25 |
£50,000 |
26.97 |
£13,485 |
|
2025/26 |
£50,000 |
26.97 |
£13,485 |
Note on break-even companies: A quirk of the system is that an R&D-intensive company that sits between loss-making and profit-making - as a break-even business - would receive an inferior effective relief rate of only 12.47%. In this situation, it is better for the business to opt out of the ‘R&D intensive’ rate to gain the 16.2% rate that would apply to the standard merged scheme.
Profit Making Companies
The effect of R&D tax relief to those companies in profit is to offset corporation tax rather than offer the cash credit scheme available to loss-making businesses.
For these companies, the corporation tax savings would be as follows, with the effective tax relief of 15% starting in the 2024/25 tax year:
|
Tax Year |
Eligible R&D Expenditure |
Effective Relief % |
Tax Relief Value |
|
2022/23 |
£50,000 |
24.7 |
£12,350 |
|
2023/24 |
£50,000 |
16.34 |
£8,170 |
|
2024/25 |
£50,000 |
15.0 |
£7,500 |
|
2025/26 |
£50,000 |
15.0 |
£7,500 |
R&D Tax Grace Period
One problem solved in the 2023 Autumn Statement is that of companies that move back and forth between ‘R&D Intensive’ and not. Previously, the accounting would need to adjust to the new rates for each qualifying period, which is especially complicated when R&D intensity fluctuates within a given tax year.
Starting with the 2024/25 tax year, businesses classed as ‘R&D Intensive’ may maintain that status (and the higher rate of relief) for a grace period of one year, hugely simplifying temporary fluctuations. It would drop to the standard merge scheme rate when the business has been non-intensive for back-to-back accounting periods.
R&D Tax Credit Company Eligibility and Compliance
Perhaps the greatest consideration you will need to make is compliance. Over the two decades of the R&D Tax Credits scheme, HMRC has been forced to deal with a large number of non-compliant claims and companies looking to misuse the system. Many of the recent changes in both the 2022 and 2023 Autumn Statements have addressed this ongoing issue and clamped down on undesirable loopholes.
Consequently, compliance is now a far more serious consideration than it used to be, with HMRC inspectors working harder to ensure that every tax relief claim is legitimate.
While in the past, smaller companies would ‘get away’ with mistakes under the basic premise that it isn’t worth HMRC’s time to chase these problems and apply the appropriate sanctions, events in recent months have shown that even the smallest claims (those of only a few thousand pounds) are being properly scrutinised to ensure full compliance.
For this reason, it is advised that professional expert help is enlisted to ensure your application for R&D Tax Credits is properly undertaken.
The PAYE and NIC Cap
A significant concern is that this UK-based tax relief system benefits UK companies and contractors. To facilitate this, a relief cap based on PAYE and NIC was introduced in 2021 and continues today. Previously, this PAYE cap was not part of the RDEC scheme for larger companies, but with the merger, it has been brought over to cover every sized business.
This cap is set to £20,000 plus 300% of the company’s ‘relevant expenditure on workers’. This term means the total liabilities for PAYE and NIC for the company’s employees and directors (regardless of R&D involvement). It also includes the PAYE and NIC of any connected externally-provided workers and sub-contracting provided by connected companies.
For businesses with less than ~£120,000 of qualifying R&D expenditure, the baseline figure of £20,000 means the cap need not be considered at all; however, those looking to make a tax relief claim exceeding that value should endeavour to understand the cap and the scheme’s relief limitations for their business.
Applying for R&D Tax Credits
When applying, it's advisable to get professional assistance from experienced R&D Tax Credit accountants. Due to the system's subtle nuances, it is unfortunately quite easy to go wrong and lose some of the financial benefits to which you are entitled.
The question of documentation is also key. While HMRC has preferred a pragmatic approach to record-keeping that can be quite forgiving, as discussed earlier, more recent changes to avoid abuse of the scheme mean that realistically thorough records are advisable.
There is, however, an understanding that dedicated timekeeping can be quite onerous and, for some, significantly undercuts the benefits of the tax relief itself. Reasonable records, rather than meticulous ones, are therefore perfectly acceptable. Simple spreadsheets indicating the time allocated to R&D are often enough to meet requirements.
Where documentation is more thorough is in the description of your research and development projects themselves. Project plans should be comprehensive, especially regarding identifying the key points that ensure your R&D time qualifies.
Remember that the definition of R&D includes the idea that projects must have a specific aim to advance further. If the information you are looking for in your company already exists in the public domain, it is unlikely your project will qualify.
For those genuinely involved in R&D, the chances are high that the tax relief will be granted.
We saw changes in the 2022 Autumn Statement, then again in the 2023 Autumn Statement. Are these current rules going to remain in force, or are more changes likely?
The R&D Tax Credits scheme changes have been made in consultation with specialist bodies throughout the past couple of years. That consultation is over, and the Conservative government has no plans to reopen the issue. As it stands, the chancellor has declared that no further changes to R&D Tax Credits will come.
However, with a General Election expected before January 2025, a change of government could initiate a review of the merged R&D Tax Credits scheme.
FAQs
Can I Obtain R&D Tax Credits if My Research and Development is Grant Funded?
Typically, no. The tax credits are there to support companies investing directly in research and development and form one of multiple schemes to further this aim. Only one such grant or scheme can usually be applied at any time.
We Are Working in Partnership With Another Company for R&D - Which of Us Claims for Tax Credits?
This particular problem has been ongoing since the dawn of R&D tax credits, as companies are unsure which of them is entitled to tax relief. Subsequently, the answer has been defined as the company that initiated the R&D project, regardless of any contract that exists between them.
Can R&D Tax Credits Be Paid to Another Party?
No, R&D tax credits must be deposited in an account belonging to the business. This is to prevent problems where an agent works on behalf of a company to obtain credits, take a cut or any other issues. Any third party owed a fee or commission for their expertise should be paid separately.
How Long Does It Take To Receive R&D Tax Credits?
While HMRC works to process tax credits as swiftly as possible, busy periods such as the year-end do see significant delays. HMRC aims to process 95% of claims in 28 days, however, in some cases, it has taken as much as 100+ days for a tax credit payment to be made.
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