31 March this year is the deadline for making backdated claims for “R&D” Tax Credits. Until now, a company has had six years to make a claim, but after 31 March that time limit will be reduced to two years. Claims for R&D in the period between 31 March 2002 and 31 March 2006 must therefore be in by this 31 March.
R&D Tax Credits were introduced in 2000 and have been modified in various ways since then, but they offer a generous tax relief for companies (but only companies, not individuals or partnerships) who have engaged in scientific research and development, as defined under the rules.
The way the tax credits work depends on the size of the company, but for “Small and Medium Sized Enterprises” (SMEs), they offer a deduction at an enhanced rate of 150% for expenditure on R&D – so for every £1,000 spent on R&D, the company can claim a deduction of £1,500 in its corporation tax computation.
It gets better – if the company makes losses for tax purposes as a result of its R&D relief, it can “sell” those losses to HMRC for 16% of the amount of the loss so created:
Brainstorm Ltd spends £20,000 on R&D during its accounting year, and when its tax computation is done, there is a loss of £30,000 for corporation tax purposes. The company can either carry this loss forward against future profits or (perhaps because it does not anticipate making any profit for a few years, or has other losses brought forward) it can choose to surrender the loss in exchange for a cash payment of £4,800.
What is R&D?
In order to qualify as R&D for tax purposes, the research must conform to guidelines published by the Department of Trade and Industry in 2004.
The R&D must be undertaken as part of a “project” that is designed to “achieve an advance in science or technology”.
The detailed guidelines are a lot more complicated than that, and not everything that seems to be R&D on a commonsense view of the matter will qualify for the 150% allowance, but companies involved in science or technology which do their own research should invest some time in checking whether they qualify or not.
A good rule of thumb is to ask yourself the following questions:
Did our project confront a genuine problem involving scientific or technological uncertainty?
That is, was there a problem which a person skilled in the field would not be able to solve using existing knowledge?
When we started to work on the problem, was it uncertain if it could be solved and how it could be solved? Again, the test is whether an expert in the field would think in these terms.
Was the result of our project a genuine advance, such as the creation of a new process or solution, or a real improvement in an existing process? Or, if we failed, was that what we were trying to achieve?
If you can answer “Yes” to all those questions, it is likely that at least part of the project would be R&D qualifying for the 150% allowance.
What expenditure qualifies for R&D Tax Credits?
Even if your project ticked the boxes above, not all the expenditure will qualify.
We will look at this in a moment but the categories of expenditure that qualify are:
Consumable items and stores such as electricity and raw materials used directly as part of the R&D
Staff costs (wages, employer’s NIC and pension contributions) directly related to R&D
Payments to subcontractors to carry out part of the R&D project (the rules here are more complex still and typically only 65% of the cost will qualify).
There is also a de-minimis limit of £10,000 – if the company spends less than this in the year on R&D, none of it will qualify.
What is and is not R&D?
Assuming the overall project involves R&D, the next step is to consider how much of the above expenses were directly related to it. It is unlikely that the whole budget for a project will qualify for the enhanced allowances. For example, the following are NOT R&D for this purpose:
Work on financing and administering the project
Research and development of non-scientific aspects of the project – so even if the new wonder machine itself involved R&D, designing a nice box to put it in will not!
Marketing, advertising, distribution, and so on
Support services – secretarial, the wages of the cleaner who mops the blood off the walls after each test run, and so on
It is important to be clear that the costs of these things are still an allowable expense for tax purposes – it is just that they do not qualify for the additional 50% allowance.
Staff costs
This is usually the trickiest area. HMRC take the view that it is extremely unlikely that any member of staff’s entire salary and other costs would qualify for the enhanced allowance.
I recently dealt with a claim where one member of staff did nothing but work on research projects for the company, and we had already agreed with HMRC that the projects in the year in question were R&D that qualified for the 150% rate.
The inspector then made the point that the staff member in question had mentioned that he had been involved in the following activities in addition to the time he spent in the lab:
He had been involved in sourcing materials for making the main component of one project
He had travelled abroad to sort out difficulties with some of the prototypes installed at clients’ premises
He had attended meetings with prospective clients to discuss their problems and how the project he was working on would help them
The inspector agreed that actually testing the materials was R&D, but shopping for them on the internet was not.
The work done at clients’ premises might or might not be R&D (in this case he agreed it was) but the travelling time was definitely not – and as the clients were all over the world, the travelling time was not inconsiderable.
The meetings with prospective clients were at best preparation for R&D, not R&D itself.
HMRC’s attitude
Since 2006, R&D claims have been dealt with at seven regional centres staffed by tax inspectors who specialise in this kind of work. This is a great improvement on the previous situation, where although there was some specialist back-up, one dealt with the local inspector – some of whom had somewhat eccentric views on what constituted R&D.
There is a story of one inspector, based in Scotland, who took the view that in the mechanical engineering sector, the last genuine piece of R&D was the invention of the wheel and everything since had been mere refinements of the original idea. This may be apocryphal, but the last time I spoke to one of the new HMRC specialists and mentioned the story he smiled ruefully and said “You may believe that, but I couldn’t possibly comment”!
On my experience of them, the R&D specialists know their stuff, are keen to help ensure that the maximum amount allowable can be claimed and even have a sense of humour – regrettably, none of these characteristics are all that common among other tax inspectors!
