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R&D Relief for Corporation Tax
What is this amazing tax deal?
This scheme was introduced some years ago to give extra tax relief for keen entrepreneurs investing in the white heat of technology where stuff needs looking into to find possible solutions, spend a fortune on researching into solutions, find that most of the solutions are wasted money, and then finally launch the one idea that actually works, and solves a problem. This type of expenditure is seen as both high-risk, and ‘to be encouraged’ by those in charge of us.
The Small and Medium-sized Enterprise Scheme
This scheme has high rates of relief. Currently, the tax relief on allowable R&D costs is 230 per cent - that is, for each £100 of qualifying costs, your company or organisation could have the income on which Corporation Tax is paid reduced by an additional £130 on top of the £100 spent.
This is a very powerful tax relief, but use of it should be exercised with care. HMRC may challenge claims, and in such cases professional advice should be taken before making any response to HMRC. Remember that if HMRC succeed in defeating a claim there will be no flexibility - they will take away 100% of the tax reduction.
And of curse, if you’ve had £2.30 per £1 taken off your taxable profits, you’re going to get £2.30 per £1 of your claim disallowed added to them, which can feel very painful if you’ve spent the tax refund. Challenges to a claim can come way after the claim is apparently accepted.
Example Claim
NB. In this example the costs are being expensed in the accounts due to uncertainty of outcome. Note that if the R&D claim was taken away it is unlikely the underlying expenditure would also be disallowed. A good tip is to capitalize R&D, and then expense it over the life of the finished project. This is attractive as earnings are enhanced, and the full tax relief is still obtained.
Which costs qualify for R&D Relief?
Nothing under £10k pa.
To qualify as R&D, any activity must meet the definitions set out by the Department of Trade and Industry (DTI). (This organisation is now known as the Department for Business, Innovation and Skills (DBIS)).These guidelines state that the activity must contribute directly to seeking the advance in science or technology
What is R&D?
The activities that constitute R&D for tax purposes are those activities undertaken which fall to be accounted for as R&D under generally accepted accounting practice and also fall within the special definitions set out in the DTI Guidelines for activities to be treated either as “directly contributing” to seeking the advance in science or technology, or as “qualifying indirect activity”. The DTI Guidelines specifically exclude certain activities from the scope of R&D for tax purposes,
The advance being sought must constitute an advance in the overall knowledge or capability in a field of science or technology, not a company’s own state of knowledge or capability alone.
Projects likely to be R&D
* Developing new operating systems or languages.
* Improving Image recognition algorithms used in security systems
* Creating new search engines using materially new search methods.
* Resolving conflicts within hardware or software, where the existence of a problem area and the absence of a known solution have been documented.
* Creating new or more efficient algorithms whose improvements depend on previously untried techniques.
· Creating new encryption or security techniques that do not follow established methodologies.
· Renewables research e.g. more efficient fan blades
· Solar panel efficiency advances
· Battery storage improvements/systems
· Unbreakable jet engine blades
· Automating a previously manual process by some new technology - but see below – not just rushing out and buying a Hitachi robot, and sacking 10 staff.
Projects unlikely to involve R&D
Some software applications or components of applications will normally follow established methodologies and not involve scientific or technological uncertainties and so not qualify as R&D, examples are:
* The handling of interactions with users. This covers areas such as development of data entry procedures and user interfaces.
* The visual presentation of information to users.
* Creating software that replicates an established paper procedure, possibly building in best practices. The fact that a previously manual task has been automated does not by itself make it R&D.
* The assembling, carrying out routine operations on, and the presenting of, data.
* Using standard methods of encryption, security verification and data integrity testing.
* Creation of websites or software using tools designed for that purpose.
However where these contribute directly to a larger R&D project they would not be excluded from the larger project.
More definitions
1) Software that is used as a tool in a larger R&D project
Where software is developed as a tool for direct use in a larger R&D project, then development of the software will qualify as R&D. An example might be data handling software needed to record and monitor the results of the R&D. The software need not of itself involve a specific advance in science or technology - if it directly contributes to a larger R&D project it will qualify as R&D.
2) Development of software as the goal of the R&D project
The following guidance relates to software projects. The guidelines apply to a software project in the same way as they apply in any other project.
· The project must seek to achieve an advance in science or technology.
· The activities that directly contribute to achieving the advance through the resolution of scientific or technological uncertainty are R&D
· There must be an advance in overall knowledge or capability in a field of science or technology, not just the company’s own state of knowledge or capability alone
· The development of a software product does not represent an advance in science or technology simply because it is software
· Routine adaptation of an existing product or process is not R&D
· Assembling components of a program to an established pattern or using routine methods for doing so is not R&D
· Combining standard technologies can be R&D if a competent professional in the field can’t readily deduce how the separate components should be combined to have the intended function
Most software projects will be intended to result in a product to be either used inhouse, licensed or sold.
The project may be to produce a product for use in the arts, humanities and social sciences (including economics). Such projects would only qualify as R&D projects to the extent that they are seeking to advance knowledge through the resolution of scientific or technological uncertainty. This is because of the general exclusion of the arts, humanities and social sciences (including economics) in the DTI guidelines on the meaning of R&D.
So finally getting your wireless printer to admit your wireless network exists, which took an engineer all day to fix, is not R&D, even if it feels like a technological breakthrough when the printer finally spits out 45 copies of your shopping list.
Successfully assembling an Ikea cupboard in less than a week? also unlikely
Software projects and system uncertainty
It may be claimed that there are always system uncertainties involved with software. It is true that there is always some uncertainty about anything. But uncertainties that can be resolved through discussions with peers or through established methods of analysis are routine design uncertainties rather than technological uncertainties. Technical problems that have been overcome in previous projects on similar operating systems, or computer architecture, are not technological uncertainties.
Where the aim of a project goes further than resolving scientific and technological uncertainties the project as a whole will not qualify as R&D, but there may be elements in the project that do qualify as R&D. Most projects for the development of a commercial product will go further than resolving technological uncertainties and so will not qualify as R&D in their entirety.
Sub Contracting
If you are doing the research then you can claim in full, even though it’s for someone else, and yours is just one bit of a larger project. BUT
IF you are USING sub contractors you can only get an uplift of 65% instead of 230%. This reflects the fact that the people doing the work are not working directly for you.
Procedures
HMRC suddenly noticed this regime was not burdened down by masses of paperwork, so after 48 working parties, and sham consultations, they have introduced FORMS, and what do they mean....bureaucracy, so job done.
IMPORTANT
Example 1 — when to submit for a 12-month period of account (one accounting period)
If the period of account in which you incur R&D costs runs from 1 January 2024 to 31 December 2024:
submit the claim notification form between 1 January 2024 and 30 June 2025. This is ONLY 6 months after the year end, so you can't do it with the CT Return etc.
And then, also by the same date, there is another form you have to file with virtually the same info on. Why require one form when two make it harder .....?
HMRC official site here:-
Notes by abell limited ©
Source HMRC © https://www.gov.uk/guidance/corporation-tax-research-and-development-tax-relief-for-small-and-medium-sized-enterprises
Contact us with any queries about this post
on abell@chartered.org or 0207 148 4785