Research and development tax relief

What is research and development (R&D) tax relief?

The UK Government offers tax reliefs via the small and medium sized enterprises (SMEs) R&D relief scheme. This scheme aims to encourage SMEs to invest in innovation and research in science and technology (ie R&D activities). 

Under the scheme, SMEs are given tax breaks for carrying out R&D activities. This is not to be confused with the R&D Expenditure Credit (RDEC), which is for large corporations. 

From 1 April 2023, the SME R&D relief scheme allows businesses to either:

• claim a tax relief (ie reduce the amount of income that tax must be paid on) - businesses can reduce the amount of yearly profit that they must pay corporation tax on by up to 186% of their ‘qualifying costs’ (ie certain costs spent on R&D activity). This may apply regardless of whether the business is profitable or loss-making. Or 

• claim a tax credit (ie have the amount of tax they must pay reduced by a monetary amount) - if the business is loss-making, they can opt to instead claim a tax credit to recover up to 10% of their ‘surrenderable loss’. For R&D intensive SMEs, this rate may be raised to 14.5%

Is my business eligible for the scheme?

To be eligible for the SME R&D relief scheme, your company must:

• be a limited company registered for corporation tax

• be a SME for the purposes of this tax relief, and 

• have carried out and spent money on R&D

What is an SME?

Under the SME R&D relief scheme, a company is an SME if it:

• has less than 500 staff 

• has either an annual turnover of less than €100 million or a balance sheet under €86 million

When determining whether your business is an SME, you need to take the figures of any ‘connected’ or ‘partner’ companies into account. 

A company is a connected company if either you hold more than 50% of the voting rights in their company, or they hold more than 50% of the voting rights in your company. If you have any connected companies, their balance sheets, turnover, and staff numbers should be included in your totals. 

A company will be a partner company if either you hold more than 25% of the voting rights or capital in their company or they hold more than 25% of the voting rights or capital in your company. If you have any partner companies, you must include a percentage of their staff numbers, turnover, and balance sheets in your calculations. The applicable percentage depends on the percentage of voting rights and capital that connects you. For example, if a partner company has 35% voting rights in your company, you should include 35% of their staff numbers, turnover, and balance sheets in your totals.

Your business’ eligibility may be affected if you’re receiving subsidies or grants or if you’re part of a Subcontracting agreement. If you’re already receiving state aid or if you’re a subcontractor, you cannot apply for this relief. However, you might be eligible for the RDEC.

What is considered R&D?

To qualify for R&D tax credits, your project:

• must be a distinct R&D project (ie not just small bits of research spread across multiple areas of your business operations)

• must be seeking to advance science or technology  (ie to increase the overall knowledge or capacity of a field). Advances in the social sciences (eg sociology) or in purely theoretical fields (eg pure maths) do not count

• must be related to your company’s trade or a trade that, based on this project, your company intends to expand into

• must involve trying to overcome an uncertainty that can’t be easily solved by a professional and to which there are no publicly known solutions

• doesn’t need to be successful

Essentially, your project will likely qualify for R&D relief if it tackles an issue in a scientific or technological field, to which the solution is unclear and not known to experts in that field. 

Note that, on 1 April 2023, new categories of work were introduced into the R&D classification for the purposes of the R&D tax relief. These include data and cloud computing and pure mathematics.

As such, a project that researches or develops an entirely new product, process, or service is generally considered R&D. So is a project that seeks to improve an existing product, process, or service in a new way. 

A project that involves an advancement that’s already been achieved may still be categorised as R&D if the details of the advance aren’t public knowledge.

Certain indirect actions that contribute to scientific or technological advancement can also be classified as work on R&D for the purposes of calculating tax reliefs. These include maintaining R&D equipment, undertaking necessary administrative work to facilitate an R&D project, and training staff on particular R&D techniques. 

Indirect actions that count as work on the R&D project are those that are not directly related to the research itself but which are directly involved in the project. For example, an administrator’s work booking research facilities for use in the project would be included, despite their not doing actual scientific or technological research. An administrator’s work paying employees who are working on the R&D project but who would have been paid anyway (eg for their work on a different project) does not count, as this administrative payroll work would have been done anyway. 

For more information, read the Government’s guidance or the HMRC’s manual on what counts as R&D.

What costs are covered by the initiative?

You’re allowed to make a claim for any qualifying R&D expenditure incurred from the start to the end of your project. 

Generally, you can claim relief on day-to-day operational costs related to the R&D activity but not the costs of:

• capital expenditure (eg money spent on renting your office space)

• product distribution 

• registering trade marks or applying for patents 

Expenses that can be claimed include:

• employee costs for employees whose work directly contributes to the R&D project (including administrative contributions, as explained above). Employee costs include salaries, National Insurance contributions, and pension fund contributions 

• costs of consumables (ie materials and resources that are used during the R&D process), including utility costs

• software costs (ie expenses for software that is necessary for the R&D process)

• subcontractor costs, ie the amount paid for subcontracted R&D work (only 65% of subcontractor costs can be claimed)

For more information, read the Government’s guidance.

How do I work out when R&D starts and finishes?

R&D starts when work to resolve the identified problem begins. The project ends when you’ve developed or discovered a solution or when you decide to end the project without discovering a solution. 

R&D work can also take place after the initial project has ended. This can occur when a new issue arises (ie you discover a new scientific or technological uncertainty) during the production of your prototype or after it has been put into use. 

However, mere design tweaks or routine repairs won’t qualify as R&D work. When determining whether a new project is considered as R&D, you should involve those that are working on it. Emphasis should be placed on what advancements the project is seeking to achieve in the field.

How do I make a claim?

There is no distinct application for the SME R&D relief scheme. You can make a claim by entering your R&D enhanced expenditure into the Company Tax Return form. 

After submitting the form, you can use the HMRC’s online service to provide the Government with further details to support your claim. 

You can make a backdated claim for R&D relief going back 2 accounting periods (ie up to 2 years after the end of the accounting period you’re claiming for).

Additional claim requirements are being introduced in 2023 in an attempt to reduce abuse of the R&D tax relief system. For any accounting period starting on or after 1 April 2023, you may need to submit a notification form to HMRC to notify them of your claim in advance of submitting it. This will be necessary if, for example, you have not claimed an R&D tax relief before. From 1 August 2023 companies may also need to submit additional evidence in support of claims. For more information on these new requirements, read the Government’s guidance on notification and on supporting information.

How do I calculate my R&D enhanced expenditure and my tax savings?

Work out your R&D enhanced expenditure by following these steps:

1. Identify the costs associated with the R&D project (ie those identified above). Note that you can only claim 65% of the payments you’ve made to subcontractors or agency staff

2. Add these costs together to arrive at your total qualifying expenditure (TQE)

3. Multiply your TQE by 86% to get the additional deduction amount that you’re entitled to

4. Add the value to your TQE to get the total amount of expenditure that you can claim tax relief on (ie your enhanced expenditure). This will be 186% of your TQE

To calculate your corporation tax savings based on this:

1. Multiply your overall taxable profit by the corporation tax rate (ie 19% for 2023/24 for profits up to £50,000). This is your original tax liability

2. Subtract your tax relief value (calculated above) from your overall taxable profit to arrive at your adjusted taxable profit

3. Multiply the adjusted profit by 19% (this is your adjusted tax liability)

4. Deduct your adjusted tax liability from your original tax liability to see how much you will save by claiming the relief

How do I calculate my surrenderable loss if I would like a tax credit instead?

If your company is trading at a loss, you can ‘surrender’ your R&D loss in exchange for a tax credit of up to 10% of your surrenderable loss. This means that, instead of paying corporation tax on less of your profits, you receive up to 10% as a deduction on the amount of corporation tax you have to pay (ie you receive a credit).

From 1 April 2023, your surrenderable loss is the lower of:

• the total trading loss suffered by your company during the relevant period (this is calculated by adding your R&D expenditure to your trading losses and deducting any relief obtained), or 

• 230% of your R&D expenditure for the related project

Additional relief for R&D intensive SMEs

The R&D tax relief and credit rates available to all SMEs under the R&D relief scheme were reduced on 1 April 2023. To help compensate for this, a new additional tax credit is being introduced for loss-making SMEs categorised as R&D intensive. These are SMEs that have R&D expenditure that makes up at least 40% of the company’s (and any connected group companies’) overall expenditure. For qualifying SMEs, the tax credit available will be up to 14.5% of surrenderable loss (this was the general rate before it was reduced to 10% on 1 April 2023).

This change has not yet been passed as law, but it’s planned and expected to pass during the summer of 2023. It will apply to claims relevant to time periods from 1 April 2023 onwards. More information on such claims will be available once the law has passed.