Understanding R&D tax relief and how PEM can help

Innovation serves as the cornerstone of progress, propelling businesses forward and fostering economic development. However, the costs associated with research and development (R&D) activities can act as a significant barrier for businesses, especially startups and SMEs. Fortunately, the UK Government recognises the importance of driving innovation and offers various incentives to support R&D efforts. Despite the common misconception, R&D tax relief is not just available to high-tech, pharmaceutical, or R&D-centric businesses but can be claimed by a broad range of companies provided they are seeking to make an advancement in their relevant field or industry.

What is R&D tax relief?

R&D tax relief is a tax incentive aimed at encouraging investment in innovation. It provides tax relief to companies that engage in qualifying R&D activities, enabling them to reduce their tax liabilities or receive a cash credit.

Qualifying R&D activities must involve seeking scientific or technological advancements by resolving scientific or technological uncertainties. This can encompass a wide range of activities, including developing new products, or processes, as well as making appreciable improvements to existing ones.

Benefits of claiming R&D tax relief:

• Financial incentive: Claiming R&D tax relief offers businesses a significant financial incentive. By reducing tax liabilities or receiving cash refunds, companies can allocate more resources towards innovation, driving further research and development efforts.
• Competitive advantage: Innovation is a key driver of competitiveness in today’s dynamic business landscape. By investing in R&D and claiming tax relief, businesses can differentiate themselves from competitors, develop cutting-edge solutions, and stay ahead of industry trends.
• Encouragement of innovation: R&D tax relief serves as a powerful tool for incentivising innovation. By offering financial rewards for R&D activities, governments stimulate businesses to invest in research and development, leading to technological advancements, job creation, and overall economic growth.
• Risk mitigation: Research and development inherently involve risks, as not all projects will yield successful outcomes. R&D tax relief helps mitigate some of these risks by providing financial support, making innovation more accessible and less daunting for businesses.

The merged R&D scheme

For accounting periods starting on or after 1 April 2024, by default, all companies undertaking qualifying R&D activities must claim under the merged R&D scheme. The scheme broadly follows the same structure as the current Research & Development Expenditure Credit (RDEC) scheme with a few notable differences.

• PAYE/NIC cap – previous restricted to the PAYE/NIC liability of R&D relevant employees, the merged scheme incorporates the more generous cap currently adopted by the SME scheme.
• Overseas R&D – The days of using overseas subcontractors and externally provided workers are over with new rules introduced to limited qualifying expenditure to work undertaken in the UK.

Subcontracted R&D has always been a problem area with both parties often trying to claim on the same project. The merged scheme looks to clear up any uncertainty by targeting the relief to the company making the decisions and bearing the risk. As such, where currently prohibited under the existing RDEC scheme, companies of all sizes will now be able to claim on the costs of contracting a (UK-based) subcontractor to undertake R&D activities on its behalf.

There will continue to be some scenarios where a subcontractor can claim R&D tax relief. These include when a company carries out R&D for a contractor which is not subject to UK corporation tax, such as charities and universities, as well as overseas entities.

SME intensive scheme

This is a more generous scheme available to loss-making R&D intensive SMEs. To be eligible to claim, companies must meet the existing SME size thresholds, be loss making (before factoring in the impact of an R&D claim) and satisfy the R&D intensity condition for the current or previous period

A company is an SME if, broadly, it has:

• fewer than 500 employees, and
• either turnover of no more than €100m, or
• gross assets of no more than €86m

A company broadly meets the R&D intensity condition if its qualifying R&D expenditure is at least 30% of its total expenditure. Total expenditure for this purpose includes any pre-trading expenditure and R&D costs capitalised as an intangible fixed asset.

Under this scheme, an eligible SME can claim an additional deduction of 86% of the relevant R&D costs incurred (this is in addition to the normal profit and loss deduction). This will increase the amount of the company’s trading loss, which it can then surrender for a repayable tax credit equal to 14.5% of the losses surrendered.

How PEM’s Business Tax team can help:

This article was correct at time of publication.

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