What are the R&D Tax Credit Rates?

Which R&D tax credit rates apply to your business?

In a modern economy, many businesses are investing time, effort and money on Research & Development (R&D) to further their trade and give themselves an edge in competitive markets. R&D reliefs are a tax relief designed to encourage greater R&D spending, leading in turn to greater investment in innovation. The relief allows a company to reduce its tax bill by an amount equal to a percentage of allowable R&D expenditure.

The details of how the relief is calculated and the R&D tax credit rates will depend upon whether you qualify for relief available to Small & Medium Enterprises (SME Relief) or those available to large companies (Research & Development Expenditure Credit).

R&D Tax reliefs for SMEs

The R&D tax credits available to Small and Medium Enterprises (SMEs) are very generous and have been increased over recent years. The enhanced deduction available has increased to 230% of qualifying expenditure from 1 April 2015 with the cash back available to loss making SMEs now being 14.5% of the surrenderable loss.

This effectively means that for every £100 you spend on qualifying R&D, you are able to deduct £230 from your profits when calculating your profits chargeable to corporation tax.

If your company had already made a loss before taking in to account the R&D expenditure, then the company would be able to claim a repayable tax credit.

Loss before taking in to account any R&D expenditure	(£100,000)
R&D qualifying expenditure	£50,000
Enhanced expenditure (130% of the above)	£65,000
	(£115,000)
Loss for tax purposes	(£215,000)
Surrenderable loss (lower of £115,000 and £215,000)	£115,000
Repayable tax credit at 14.5% of surrenderable loss	£16,675

So in this example the company spent £50k on R&D and was able to claim a cash refund of £16,675 from HMRC.

For loss-making companies this provides a cash refund of 33.35% of qualifying expenditure.

As can be seen from the above, R&D credits can be very valuable for SMEs.

R&D Tax Relief for Large Companies - Research & Development Expenditure Credit (RDEC).

Large companies can also qualify Research & Development tax relief, however the basis of the relief is completely different to that available to SMEs.

Large companies are eligible to claim Research & Development Expenditure Credit (RDEC).

Large companies can only claim RDEC from 1 April 2016. Prior to that they were able to claim a super-deduction based on expenditure but this was abolished with effect from 31 March 2016. For expenditure between 1 April 2013 and 31 March 2016, large companies could elect to use RDEC instead of large company super-deduction.

The RDEC rates have been as follows:

Pre 1 April 2015 expenditure	10%
Expenditure between 1 April 2015 and 31 December 2017	11%
Expenditure after 1 January 2018	12%

The RDEC scheme is often referred to as an Above the Line (“ATL”) credit.

The reason is that it is recognised above the line in the company accounts. This is different to SME relief which is purely a tax adjustment. RDEC is treated in a similar way to grants by being processed in this way.

The ATL nature of the credit can be seen from the example below. This example assumes pre 31 December 2017 expenditure and so is using the RDEC rate at 11%. The CT rate used is 20% (which applied for accounting periods pre 1 April 2017).

	No RDEC claim	With RDEC claim
Turnover	1,500,000	1,500,000
Less: qualifying R&D costs	(400,000)	(400,000)
Other costs	(200,000)	(200,000)
R&D Tax Credit @ 11%		44,000
Profit before tax	900,000	944,000
CT @ 20%	(180,000)	(188,800)
Less: R&D Tax Credit		44,000
Tax payable	£180,000	£144,800

Effective benefit of RDEC between April 2015 and December 2017 = £35,200 or 8.8% of the £400,000 qualifying R&D spend

From 1 January 2018 the RDEC rate increased to 12%. This is reflected in the example below:

	No RDEC claim	With RDEC claim
Turnover	1,500,000	1,500,000
Less: qualifying R&D costs	(400,000)	(400,000)
Other costs	(200,000)	(200,000)
R&D Tax Credit @ 12%		48,000
Profit before tax	900,000	948,000
CT @ 19%	(171,000)	(180,120)
Less: R&D Tax Credit		48,000
Tax payable	£171,000	£132,120

Effective benefit of RDEC after 1 January 2018 = £38,880 or 9.72% of the £400,000 qualifying R&D spend

The above examples assume that the company is profit-making and can utilise the expenditure credit to reduce its CT liability. What happens if the company is loss-making.

The calculations then become quite complex and how the expenditure credit is applied follows a strict set of steps as set down in the tax legislation.

How the expenditure credit is applied is as follows:

The credit must first be used to settle your Corporation Tax liability for the accounting period. However, you’ll need to pay Corporation Tax on the credit. If the credit means you are due a repayment of Corporation Tax that has already been paid, the interest will be calculated on a last in, first out basis (LIFO).
If you have RDEC remaining after step 1, the amount is reduced by applying a notional tax charge to it. The notional tax charge must be based on the main rate of Corporation Tax for the accounting period. If the amount remaining after step 1 is higher than what the value of the total credit minus the notional tax charge would have been, you must use the value of the total credit minus the notional tax charge in step 3.
The credit must not be higher than your company’s total expenditure on R&D workers’ PAYE and NICs for the accounting period. The amount over this limit will be added to any expenditure credit in the next accounting period.
The remaining amount is used to pay any outstanding Corporation Tax liabilities for any accounting periods.
The credit can be surrendered in whole or part to any group member.
The credit can be used to discharge any other company liabilities, like VAT or liabilities under a contract settlement.
The final amount can be repaid to the company.

Let us consider another example where the company is loss-making:

	No RDEC claim	With RDEC claim
Turnover	500,000	500,000
Less: qualifying R&D costs	(350,000)	(350,000)
Other costs	(280,000)	(280,000)
R&D Tax Credit @ 12%		42,000
Profit(/Loss) before tax	130,000	88,000
CT @ 19%	Nil	Nil
Less: R&D Tax Credit		42,000
Tax payable	Nil	Nil

Following the steps set out above relief will be given for the £42,000 RDEC as follows:

Step 1 – Used against current year corporation tax liability = Nil. Carry forward £42,000 credit to step 2.
Step 2 - The credit is then capped at the ‘net value’ of the RDEC, which is £42,000 less tax on that amount at 19% = £34,020. The credit in excess of the cap of £7,700 is carried forward and offset against the corporation tax liability of a subsequent period. The ‘net value’ of £30,800 is lower than the credit carried forward from Step 1, so the ‘net value’ is carried forward to Step 3.
Step 3 - The ‘net value’ of £34,020 is then capped at the company’s PAYE and Class 1 NIC liability relating to R&D staff for the accounting period. In this case we will assume that this is £25,000. The excess above this amount (£9,020) is carried forward and treated as a credit for the next accounting period.
Steps 4-6 – For this example we will assume that the company has no outstanding liabilities and that the company is not part of a group, so the credit of £25,000 is taken to step 7.
Step 7 - The credit of £25,000 will be payable in cash to the company.

What is Research & Development (R&D) tax relief?

The definition of R&D and whether it qualifies for relief will be the same whether you are a large company or an SME.

The work that qualifies for R&D relief must be part of a specific project to make an advance in science or technology. It cannot be an advance within a social science like economics or a theoretical field like pure mathematics.

The project must relate to your company’s trade - either an existing one, or one that you intend to start up based on the results of the R&D.

To get R&D relief you need to explain how a project:

Looked for an advance in science and technology.
Involves uncertainty. You should be researching or developing something that is not known to be scientifically or technology feasible when you make or discover it. This means that your company or experts in the field cannot already know about the advance or the way you achieved it.
Tried to overcome this uncertainty. You should show that the R&D needed research, testing and analysis to develop it. You need to be able to explain the work you did to overcome the uncertainty. This can be a simple description of the successes and failures you had during the project.
Could not be easily worked out by a professional in the field. You should explain why a professional could not easily work out your advance. You can do this by showing that other attempts to find a solution had failed. You can also show that the people working on your project are professionals in that field and get them to explain the uncertainties involved.
May develop a new process, product or service or improve on an existing one. The process, product or service can still be an advance if it has been developed by another company but is not publicly known or available.

Qualifying Expenditure

Further information in relation to qualifying expenditure can be found here (link to main R&D article).

The main categories of qualifying expenditure are as follows:

Costs of staff/workers (directly employed or externally provided)- You can claim 65% of the relevant payments made to an external agency if they provide staff for the project
Consumables – Materials, utilities, travel costs
Payments to clinical trial volunteers

ETC Tax can help with your R&D tax relief claim

Making a claim for R&D Tax Credits is not just a numbers exercise and a company should seek expert advice so as to maximise the value of their claim. One of our areas of expertise is assisting clients to make claims for R&D tax claims.

We will work with you to assess whether the R&D activities you have been undertaking will qualify for the relief and to ensure that you are aware of all the categories of expenditure that you can claim so as to maximise claim value.

We will also prepare a detailed R&D report to accompany your claim which will explain the nature of the projects, the areas of uncertainty and advances involved to demonstrate to HMRC why the activities qualify for relief.

We can also help to answer:

If you have a question about R&D tax credits, speak to one of our chartered tax advisers today.