In the UK, the R&D tax credit schemes play a key role in incentivising investment in research and development by reducing the costs of innovation. This means that for any UK-based business looking to invest in scientific or technological advances, it could be eligible to claim a significant proportion of the costs or expenditure back from HMRC.
The following guide for overseas companies on claiming R&D tax credits for UK-based operations looks at what these credits are and how much can be claimed. We also look at the eligibility requirements and application process to claim this form of tax relief in the UK, together with the updated rules in respect of R&D tax credits for 1 April 2023.
What are R&D tax credits?
R&D tax credits refer to certain types of Corporation Tax relief on a qualifying Research and Development (R&D) project based in the UK for UK-registered companies.
In broad terms, R&D tax relief supports companies that work on innovative projects in the fields of science and technology, where the project may research or develop a process, material, device, product, service or source of knowledge, or improve an existing one.
Different types of R&D tax relief in the UK
There are two different types of R&D tax relief potentially available for a company to claim, including overseas companies operating in the UK, where the applicable type will depend on the size of the company and whether or not the project has been subcontracted to that company. The two different types of tax relief include the following:
Small and medium sized enterprise (SME) R&D tax relief: for SMEs with less than 500 staff and a turnover of under €100 million or, alternatively, a balance sheet total under €86 million. The staff, turnover and balance sheet of any linked or partner enterprise should be included in the totals when assessing eligibility for SME R&D tax relief;
R&D expenditure credit (RDEC): for larger companies, where they can instead claim expenditure credit for working on R&D projects.
RDEC can also be claimed by SMEs excluded from claiming SME R&D tax relief, for example, if they have been subcontracted to do R&D work by a large company, or if their project has already received State aid or been fully subsidised in some other way.
How much are R&D tax credits in the UK?
Both the R&D tax relief and expenditure credit schemes offer generous support to incentivise firms investing in R&D, including overseas companies with operations based in the UK. Below we look at what each scheme offers by way of incentives.
SME R&D tax relief
The R&D tax relief for SMEs will allow a company to:
- deduct an extra 86% of their qualifying costs from their annual profit, in addition to the normal 100% deduction, to make a total of a 186% deduction
- claim a payable tax credit if the company has claimed relief and made a loss, where the payable credit is worth up to 10% of the surrenderable loss.
R&D expenditure credit
The R&D expenditure credit (RDEC) will allow a larger company to claim expenditure credit on some of its qualifying expenditure costs. The expenditure credit is calculated as a percentage of qualifying R&D expenditure, where the rate from 1 April 2020 up to and including 31 March 2023 was set at 13%, increasing to 20% from 1 April 2023.
When it comes to RDEC, whether the company makes a profit or loss, some or all of this expenditure credit can be used to settle the company’s Corporation Tax liabilities, or those of any group. In some circumstances the expenditure credit can also be used to settle other tax liabilities the company is responsible for or lead to a payment of credit to the company.
Qualifying costs or expenditure
Under either scheme, tax relief can be claimed on some of the costs incurred from the start to the end of the project, where R&D starts when work begins to resolve the scientific or technological uncertainty and ends when that uncertainty is resolved or the work ceases.
Qualifying costs or expenditure can include consumable items, such as fuel, materials, power and water. It can also include the cost for clinical trial volunteers, where applicable, data licence and cloud computing costs after 1 April 2023, staff wages, and a percentage of subcontractor or externally provided worker costs, such as agency staff. However, a claim cannot be made for the production and distribution of goods and services, any capital expenditure, the cost of any land, the cost of patents and trademarks, or for rent or rates.
Large companies may also be able to claim for contributions made for independent R&D.
Eligibility criteria for R&D tax credits
Under either scheme, a company can only claim R&D tax credits if its project meets the standard definition of R&D, where any activities that directly contribute to an advance in either science or technology through the resolution of scientific or technological uncertainty will be classed as R&D. As such, a project will qualify for tax relief if it:
- seeks to make an ‘advance’ in either science or technology
- through the resolution of ‘scientific or technological uncertainty’
- where the activities involved ‘directly contributed’ to that advance.
Importantly, it is not possible to claim for R&D in the arts, humanities or social sciences, including economics although, as from 1 April 2023, mathematical advances in themselves are now treated as science under the new rules relating to R&D tax credits.
A scientific or technological advance
An advance in science or technology essentially means an advance in overall knowledge or capability in the field in question, rather than a company’s own state of knowledge or its capability alone. A scientific or technological advance may have tangible consequences, such as a process which generates less waste or a new and more efficient cleaning product, or more intangible outcomes, such as new knowledge or cost improvements.
Even if the scientific or technological advance sought by a project is not achieved or fully realised, R&D will still take place. Equally, if a particular advance in science or technology has already been achieved, or attempted but details are not publicly available, such as where it is a trade secret, any work to achieve such an advance can still be a qualifying advance. However, the routine analysis, copying or adaptation of any existing process, material, device, product or service will not be an R&D advance for tax relief purposes.
Equally, a process, material, device, product or service will not become an advance for the purposes of R&D tax credits merely because science or technology is used in its creation. Work undertaken using science or technology, but not advancing the scientific or technological capability as a whole is not a qualifying advance.
Scientific or technological uncertainty
Scientific or technological uncertainty for the purposes of R&D tax credits exists when the knowledge of whether something is either scientifically possible or technologically feasible, or how to achieve this in practice, is neither readily available or deducible by a competent professional working in that field. This type of uncertainty will often arise from turning something that has already been established as scientifically feasible into a cost-effective, reliable and reproducible process, material, device, product or service.
In contrast, if the uncertainty can be readily resolved by a competent professional within the field, this will not qualify as a scientific or technological uncertainty. Equally, improvements, optimisations and fine-tuning not materially affecting the underlying science or technology will not be work to resolve scientific or technological uncertainty.
When it comes to direct contribution, with the exception of qualifying indirect activities, a company can only claim for activities that directly contribute to the resolution of scientific or technological uncertainty. To directly contribute to achieving an advance in science or technology, an activity, or several activities in combination with each other, must attempt to resolve an element of the uncertainty associated with achieving the advance.
Activities which directly contribute to R&D include:
- activities to create or adapt software, materials or equipment needed to resolve the scientific or technological uncertainty, provided that the software, material or equipment is created or adapted solely for use in R&D
- scientific or technological planning activities
- scientific or technological design, testing and analysis undertaken to resolve the scientific or technological uncertainty.
Activities which do not directly contribute to the resolution of either scientific or technological uncertainty include:
- the range of commercial and financial steps necessary for innovation, and for the successful development and marketing of a new or appreciably improved process, material, device, product or service
- work to develop non-scientific or non-technological aspects of a new or appreciably improved process, material, device, product or service
- the production and distribution of goods and services
- administration and other supporting services
- general support services, such as transportation, storage, cleaning, repair, maintenance and security, and
- qualifying indirect activities.
Qualifying indirect activities for R&D tax credits
In addition to those activities that directly contribute to the resolution of scientific or technological uncertainty, there are certain activities forming part of a project that will still qualify for R&D tax credits as ‘qualifying indirect activities’. These include:
- scientific and technical information services, insofar as they are undertaken for the purpose of R&D support, like the preparation of the original report of R&D findings
- indirect supporting activities, like maintenance, security, administration and clerical activities, as well as finance and personnel activities, insofar as undertaken for R&D
- ancillary activities essential to the undertaking of R&D, such as taking on and paying staff, leasing laboratories, as well as maintaining equipment, including computers used for R&D purposes
- training required to directly support an R&D project
- research by students and researchers carried out at universities
- research, including relevant data collection, to devise new scientific or technological testing, survey or sampling methods, even where this research is not R&D in its own right
- feasibility studies so as to inform the strategic direction of a specific R&D activity.
Any activities which do not directly contribute to the resolution of scientific or technological uncertainty, other than the above qualifying indirect activities, will not be R&D.
How to claim R&D tax credits in the UK
A claim for R&D tax credits will need to be made via the Company Tax Return, where a claim can be made going back two accounting periods. However, before claiming under either the SME or large company scheme, the applicant must ensure the tax relief claim will be valid, where the company may be liable to pay a penalty if it makes an ineligible claim.
To claim SME R&D tax relief, the applicant needs to be an SME and be able to show how its project meets the standard definition of R&D. This essentially means being able to show advances in the field, not just for the applicant’s business, as well as a scientific or technological uncertainty, where the applicant or any expert in the field cannot already know about the advance or the way to solve it. The applicant must then go on to explain the work undertaken to overcome the scientific or technological uncertainty and that a professional in the field could not easily work out the advance in question.
If a company is making a claim for tax relief as an SME for the first time, they may be able to apply to HMRC for advance assurance. This is a voluntary scheme used to give SMEs a guarantee that any claim for R&D tax credits will be accepted if they are in line with what was discussed and agreed in their application, and claimed within the first three accounting periods. Advance assurance does not mean that a claim for R&D tax credits has been made, where the SME must still submit its claim in due course using the Company Tax Return.
Similarly, to claim RDEC, the applicant will again need to carefully consider if its activity will be eligible for R&D tax credits. If the activity will not be recognised as a scientific or technological innovation, or has already been conducted or is currently being conducted elsewhere, it is very unlikely this will be eligible. Detailed guidance can be found on the website for the Department for Science, Innovation & Technology (DSIT), although companies are strongly advised to seek expert advice before submitting any claim.
Additionally, in the context of claims for R&D tax relief or RDEC, the applicant must:
- check if they need to submit a claim notification form to notify HMRC in advance of their claim (for accounting periods beginning or after 1 April 2023);
- submit an additional information form to support their claim (from 1 August 2023).
Updated rules on R&D tax credits
On 1 April 2023, new guidelines were introduced which apply to accounting periods beginning after 31 March 2023. These guidelines can be found online (CIRD 81910), although companies should continue to refer to the 2004 guidelines (CIRD 81900) when preparing claims for accounting periods which began before 1 April 2023.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.