Innovation is the lifeblood of progress in any successful business. It drives growth, propels change, and keeps companies at the forefront of their industries. However, innovation does not come without investment. Research and development (R&D) activities can consume a substantial portion of your business’s resources, but there is a silver lining: R&D tax credits.
Eligible companies can use R&D tax credits to offset the cost of innovative projects in their business, but understanding what you can and cannot claim is crucial. Let’s explore them in detail.
What are R&D tax credits?
R&D tax credits are Government incentives designed to encourage companies to invest in innovation. They work by reducing a business’s corporation tax liability or even providing a cash sum for some loss-making companies.
While there are currently two separate R&D schemes: the SME and the R&D expenditure credit (RDEC). However, these schemes are set to merge into a more streamlined system on 1 April 2024.
Qualifying activities for R&D tax credits
Regardless of which scheme your company uses, the rules surrounding what does and does not count as qualifying R&D expenditure remain the same. First and foremost, the work must aim to make an advance in an area of science or technology.
This can be through creating new processes, products, or services or improving existing ones. Here are some examples:
- Developing new software: Creating new software solutions or improving existing software.
- Designing innovative products: From conceptual design to prototyping, efforts made towards creating new products qualify.
- Process improvements: Enhancing existing production processes for efficiency, sustainability, or quality.
- Overcoming technical challenges: Efforts to solve industry-specific technical problems can also qualify.
It’s important to note that overseas expenditure will generally not be eligible for R&D relief.
As we can see, while the scope of R&D tax credits might seem highly limited to tech or science-focused businesses, the net is wider than many people think. In fact, billions of R&D tax credits go unclaimed each year, in part due to businesses wrongly assuming it does not apply to them.
If your business is building or innovating to create new, novel, or cutting-edge methods, processes, or technologies, then it could qualify, regardless of its industry.
Furthermore, an R&D project may still qualify for tax relief even if it fails to achieve what it sets out to do.
Now, let’s take a look at qualifying costs for R&D activities. Only expenditures that are considered ‘direct’ or ‘indirect’ contributors to your project will qualify. Any ‘routine’ tasks you carry out will not be covered.
- Examples of direct expenditures include the costs of carrying out experiments and trials, raw materials and project management.
- Meanwhile, activities like payroll administration, cleaning and IT support will be considered indirect expenditures.
- Routine expenditures typically include marketing, routine testing and commercial analysis.
Staff costs and expenditure
A significant portion of R&D tax credit claims are for staff costs. This includes salaries, wages, National Insurance contributions, and pension fund contributions for staff directly involved in R&D activities.
Subcontracted R&D work
New rules coming into force in April 2024 will focus more on the company that contracts out the R&D work rather than the company doing the R&D.
That means that if you’re outsourcing part of your R&D activities, these expenses can also qualify for R&D tax credits. This is particularly relevant for firms collaborating with external experts or specialists to achieve their R&D objectives.
Expenditure on materials consumed or transformed during the R&D process can be claimed. This includes things like chemicals, materials for prototypes, and software used directly in R&D.
For technology firms, software development is often at the heart of R&D. This includes developing new algorithms, data architecture, and user interfaces. The costs associated with these activities, including software testing and debugging, can be included in R&D tax credit claims.
Do’s and dont’s for a successful claim
To ensure a successful R&D tax credit claim, keep comprehensive records of all R&D activities.
Documenting the challenges faced, solutions developed, and the iterative process of your R&D projects is vital.
However, avoid overstating your claim or including activities that don’t directly contribute to R&D, as this could lead to scrutiny or rejection of your claim.
As mentioned earlier, a new combined R&D scheme will replace the current SME and RDEC schemes later this year. Here’s what you can expect from the upcoming changes
Credit and tax rates
The new unified approach will apply to all companies, regardless of their size. The key features of this merged scheme include a 20% credit rate (in line with the RDEC regime) and a more favourable tax rate for loss-making companies.
R&D intensity threshold
The R&D intensity threshold (the proportion of qualifying R&D expenditure compared to total expenditure) will drop from 40% to 30% for companies with accounting periods beginning on or after 1 April 2024.
These companies can claim an enhanced deduction of 86% on their qualifying R&D expenditure and a repayable tax credit of 14.5%. The merged scheme will not include the subsidised R&D restrictions from the current SME regime, meaning relief will not be reduced if R&D costs are subsidised.
Administration and compliance
From April 2023, companies that haven’t claimed R&D tax credits in the past three years will need to notify HMRC of their intention to file a claim within six months from the end of the period the claim relates to.
Also, as of August 2023, all claims must be made digitally, and companies must fill out an additional information form detailing their R&D project and activities through a new online portal.
How to get the most out of your claim
R&D tax credits are an excellent way for businesses of all shapes and sizes to recoup some of the costs associated with innovation. Understanding what qualifies as R&D and maintaining proper documentation is key to maximising these benefits. However, navigating the R&D tax credit rules can be challenging, especially with so many changes on the horizon.
At Business Partners, we believe innovation should be a rewarding journey, not a financial or administrative burden. As R&D tax credit specialists, we can guide you through the claims process, helping you identify eligible activities, quantify qualifying expenditures, and back up your claim as much as possible.
Get in touch with us to find out how Business Partners can help you get the most out of your R&D claim.