R&D tax credits: What they are, how they help cash flow, and how to claim

If you've spent money developing software, building your website or researching new technology, for example, you could claim research and development (R&D) tax credits.

The UK government introduced R&D tax credits (also called R&D tax relief) over 20 years ago. The idea behind the scheme was to reward businesses for innovation they've demonstrated and provide incentives for doing innovative work in the future.

You can use this tax relief to pay less corporation tax, claim a tax rebate or receive a cash payment. Sound like a good idea? Read on to learn more about the benefits of claiming R&D tax credits and how to apply.

What are R&D tax credits?

R&D tax credits are a financial incentive the government pays to innovative companies that do research and development (R&D). They allow you to claim back part of the money you've spent on R&D over the past financial year. In fact, if eligible, you can continue claiming this tax relief every year – for however long your R&D lasts.

R&D tax credits give you the option of accessing funds without racking up interest or giving away ownership – common obstacles whenever you seek outside investment.

Who is eligible for R&D tax credits?

HMRC has a very specific definition of R&D, so you must meet that to be able to qualify for the tax relief (see Which R&D projects qualify? below).

It's a common misconception that R&D tax credits are reserved only for scientific or medical companies, or businesses developing advanced technology. This isn't the case – the industry in which you operate has no bearing on whether you're eligible.

In truth, the only condition is that you're undertaking activities that introduce new products or services, or improve upon what's already available.

Which R&D projects qualify?

When you apply for R&D tax credits, you typically claim for a 'project' (or 'projects'). Your R&D project could relate to improving or developing a new process, service or product based on a problem you've identified.

It might even be to improve an existing set-up, if you want to do something in a new way and your innovation will make it more efficient.

You can't claim for simply developing your product as planned. The solution you create must be innovative and must not already exist within your industry. It has to be a new way to solve a problem. You must also intend to use the results to move forward with your business.

A key element of the fund is that you must be 'uncertain' about whether technology or science will solve the problem – but you're going to try. You need to consider whether:

• you, or a competent team member, could look at your problem and get to the solution with time and investment

• if others within your industry have common knowledge that could solve the problem

Remember: you can only qualify if your project is based on technological uncertainty, not routine uncertainties.

Read more:

• What makes an R&D project eligible (GOV.UK)

Examples of R&D projects that could claim tax credits

• A manufacturing business needs to print a new design in a specified colour onto a plastic base. The existing methods and inks don't have the correct properties to make the ink stick.

  After some research, the company can't find a solution, so starts a project to identify the correct composition of ink, and to devise improvements to processes that will make sure the ink binds correctly.

• An architect designs a large roof over an open central hall area. The design is unique and has little visible support, which causes a problem when it comes to actually constructing it. The design will be unstable if built using conventional methods, and after research the architect still can't find a solution.

  The architect starts a project to find a new structural assembly process, which will also solve the load-bearing issues to bring the roof design to life.

• A creative agency grows to a scale where managing clients becomes cumbersome and communication is spread across a number of different tools. It needs one system that has both a client view and an internal view, and allows people to upload design files and make comments – while being custom to its monthly package structure.

  There is nothing on the market to fulfil this, so the agency begins a project to develop a tool specific to its industry.

Why are there two R&D tax credit schemes?

Currently, there are two R&D tax credit schemes running. Which one you apply for will depend on your size of business.

Small or medium-sized enterprise (SME) R&D tax relief

This scheme is aimed at UK companies with:

• fewer than 500 employees

• turnover of less than €100 million, or a balance sheet total under €86 million

That covers micro, small and medium-sized businesses.

Your business's financial position at the time of filing your tax return determines how much money you can claim back.

• If your business is making a profit: The tax relief on allowable R&D costs is 230%. That means you can deduct an extra 130% of your qualifying costs from your yearly profit, as well as the normal 100% deduction, to make a total 230% deduction.

• If your business is making a loss: You can surrender your losses (that is, use your qualifying R&D expenditure as a tax credit) and claim up to 14.5% of the surrenderable loss as a cash payment.

Read more:

• SME R&D tax credits (GOV.UK)

R&D expenditure credit (RDEC)

This scheme is for UK companies that don't qualify for the SME tax relief – in other words, those that have:

• at least 500 employees

• turnover of no less than €100 million, or a balance sheet total of €86 million or more

RDEC is also available to SMEs and large companies that have:

• been subcontracted to do R&D work by a large company

• received a grant or subsidy for their R&D project

Unlike with the SME scheme, RDEC treats profit-making and loss-making companies equally. The RDEC rate is 13%, but because it's paid after corporation tax has been deducted (19% at the time of writing), you receive 11p for every £1 you spend.

Read more:

• R&D expenditure credit (RDEC) (GOV.UK)

Claiming R&D tax credits: Example

Your business is in the early stages of developing a durable, biodegradable material that can be used as an eco-friendly plastic alternative.

You've spent £200,000 over the past financial year on R&D, such as testing, building prototypes and so on. As your product is not yet market-ready, you're not making a profit.

By filing an R&D tax credit claim under the SME scheme, you could receive a cash sum of £66,000.

This cash injection sets your business up for far greater progress in the next financial year. You can use this cash on whatever aspect of R&D takes your product to the next level. And don’t forget – you can repeat the process every year to boost cash flow until your R&D activity is complete.

What types of costs do the R&D tax credits cover?

Great news: a lot of R&D costs qualify. Here's a rundown of the main ones (not a complete list), and the amount you can claim back in tax relief:

• Direct staff costs (100%) – costs for employees directly involved in the R&D project, including:

  • salaries

  • employers' National Insurance contributions

  • reimbursed out-of-pocket expenses

  • employers' pension contributions

• Externally provided workers (up to 65%): Money spent on workers from outside the business, such as:

  • freelancers

  • agency staff

  • contractors

• Unconnected subcontractors (up to 65% on SME scheme; RDEC doesn't usually qualify): Projects or work you've outsourced to another company.

• R&D consumables (100%): Items you've used up or otherwise transformed in the course of your R&D activity, including utilities like electricity, gas and water. (This can get tricky if your consumables are included within your rent.)

• Software (100%): Software you use specifically for your R&D work.

• Prototypes (100%): Money you spend on designing and building prototypes to test your development work.

• Clinical trial volunteers (100%): Money paid to people who have volunteered in clinical trials.

• Contribution to independent research (100%; large companies only): Payments made to other companies doing eligible R&D.

What R&D costs do not qualify?

You won't be able to claim R&D tax relief for the following costs:

• Capital expenditure: Money used to buy, improve, or extend the life of fixed assets such as buildings, equipment, vehicles or land

• Patents or trademarks

• Producing and distributing goods or services

• Telecommunications and data

• Shareholder dividends

• Any benefits in kind, such as private medical cover or company cars

• Pure product development

How do I claim R&D tax credits?

You can claim R&D tax credits up to two years after the end of the relevant accounting period.

To do so, you need to enter your enhanced expenditure (see below) into the full Company Tax Return form (CT600). You can then use the government's online service on GOV.UK to support your claim.

Working out your enhanced expenditure

You need to:

• calculate the costs that you can attribute directly to your R&D (according to HMRC's definition of what R&D involves)

• reduce any payments to subcontractors or outside staff (agency staff, freelancers and so on) to 65% of the original cost

• add all costs together

• multiply the figure by 130% to get the additional deduction

• add this to the original figure for your R&D spending

• enter this enhanced expenditure figure into your tax return

Read more:

• Claiming R&D SME tax credits (GOV.UK)

• Claiming RDEC (GOV.UK)

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