Guides: R&D tax credit calculation examples
R&D tax credits are one of many government incentives designed to encourage UK companies to invest in innovation by providing businesses access to cash as a reward for their activities. We have created some R&D worked examples to illustrate the financial benefits of making an R&D tax credit claim, how these are calculated and what this could mean for your business.
Who can make a claim?
Available to both SMEs and large companies alike, if your business is attempting to resolve scientific or technological uncertainties then you may be carrying out qualifying activity eligible to benefit from the R&D Tax Credit scheme.
3 factors that can affect the value of your R&D tax credit claim:
- The size of your company
- The amount of Corporation Tax you pay
- Whether you are profit or loss-making
Offering a maximum return of up to 33p (33%) per £1 spent on R&D expenditure, the exact rate of return will depend on the size of your business, the amount of Corporation Tax you are required to pay and whether you are profit or loss-making. No matter your position, there is benefit in making a claim, as returns can vary between 14.5% and 33% for SMEs.
Large company or SME?
Aside from being profit or loss-making, the difference in claim value will depend on your size, with both the Research and Development Expenditure Credit (RDEC) scheme and SME scheme differing in the amounts of cash benefit a company can receive.
To be recognised as an SME under the scheme you must employ up to a maximum of 500 people with either an annual turnover not exceeding €100 (£86) million or a balance sheet not exceeding €86 (£74) million.
Factors such as grants, subsidies and state aid can change the status of an SME by R&D tax definition to that of a large company, making you eligible for the RDEC scheme.
It’s also important to note that if your staff headcount is lower than 500, but you exceed both the turnover and gross asset thresholds, you will be classed as a large company for R&D relief and be assigned to the RDEC scheme.
What can be included in an R&D tax credit claim?
The main part of an application for R&D tax credits is knowing what you can and can’t claim for. In most instances you can claim R&D relief on revenue expenditure, i.e. day-to-day operational costs, but not capital expenditure (money spent on fixed assets such as land and buildings), or the cost of using or creating a trademark and the production and distribution of goods and services within claim. Below we have outlined some key areas which you can include in your claim:
What costs are eligible for R&D tax credit?
- Direct staff costs – this is the cost of paying your employees who have worked directly on the R&D project and include costs such as; gross salaries (including wages, overtime and cash bonuses), employer NI contributions, employer pension contributions and certain reimbursed business expenses.
Calculating your direct staff costs:
- Add up the total costs above for each employee who worked on the project
- Multiply this by the portion of the time they spent on the project in the claim year i.e. 40%
- Do this for all employees that worked on the project
- Subcontracted R&D – this usually means that a portion of your R&D project has been outsourced to another company for an agreed amount. Companies can claim up to 65% of their subcontracted R&D costs, but only under the SME scheme.
- Externally Provided Workers (EPWs) – external workers employed to work specifically on an R&D project may be eligible for an R&D tax credit claim. External workers are individuals provided through a recruitment company or staffing provider e.g. agency staff, third party staff, contractors, or freelancers. Tax credit relief allows you to claim 65% of the payments made to the agency.
Calculating EPW costs
- Calculated in a similar way to direct staff, the cost of the EPW will be determined based on the amount of time they spend on the R&D project you are claiming for. Note that VAT is usually not counted as part of the cost
- Once the time spent is identified, multiply by 65% to identify the maximum amount eligible to claim
- Consumables – materials and resources that are used up / consumed in your R&D process, such as water, fuel and power can be included in your claim. In addition, materials consumed or transformed in the R&D process can be included, such as materials used in the construction of prototypes. These costs fall into one of two categories either apportioned expenses or wholly R&D expenses. You can not claim for materials which were not used up in the R&D process or used for products that were sold onto a client.
- Software – software which was needed for R&D or involved in R&D activities may be included but must have been developed / purchased for the R&D project; for example, CAD or FEA software used for development, hosted development kits such as Sage Development, and project management software. If the software was partially used for the R&D project, then its price must be apportioned. However general software such as email hosting, Microsoft Office, ERP and MRP software costs and website hosting would be excluded.
- Clinical volunteers – usually only relevant to pharmaceutical firms, the payments made to volunteers in clinical trials are eligible.
In addition, large companies can include contributions to individuals or certain research organisations where qualifying R&D work was carried out.
How are R&D tax credits calculated?
R&D tax credit calculation for profit making SMEs
In general, profitable SMEs can benefit from average savings of 25%, so if a company were to spend £100,000 on R&D projects and make an R&D tax credit claim they would be able to reduce their Corporation Tax (CT) by up to £25,000, ultimately deducting 130% of the qualifying costs from their yearly profit in addition to the normal 100%; a total 230% saving.
How it works:
- Calculate your qualifying expenditure (QE) using the list above. This will be the amount that you are declaring as being spent on qualifying R&D.
- Enhance your QE by multiplying by 130%; artificially increasing your R&D expense for the year and reducing your taxable profit.
- Subtract your original CT amount from your new rate to reveal your CT saving.
SME #1 made profits of £400,000 for the year
Qualifying expenditure: £100,000 (already in accounts as expenditure)
Corporation Tax before R&D tax credit claim: £76,000
£100,000 x 130% = £130,000 (uplift)
£400,000 – £130,000 = £270,000 (revised profit)
£270, 000 x 19% = £51,300 (Corporation Tax)
£76, 000 – £51,300 = £24,700 (Corporation Tax saving)
£24,700 approx. 25% saving from R&D tax credits
Find out how much you could save with our online tax calculator.
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R&D tax credit calculation for loss-making SMEs
Loss-making SMEs can secure cash benefit from a successful claim, they also have the option of not surrendering the R&D loss but rather carrying the loss either forwards or backwards against profits.
How it works:
- Calculate your QE using the list above. This will be the amount that you are declaring as being spent on qualifying R&D.
- Enhance your QE by multiplying by 130%; as the company is loss-making, their losses will increase.
At this point there are two routes you could take, to either cash in your losses or carry them forward.
- Cash in or surrender losses – this is calculated as your revised loss for the year or 230% of your QE (whichever is lower) and is surrendered to HMRC for a cash tax credit at a rate of 14.5%.
- Carry forward losses – this is an alternative to cashing in and means that the losses can be carried forward and offset against future taxable profit.
SME #2 made a (£300,000) loss for the year
Qualifying expenditure: £100,000 (already in accounts as expenditure)
Corporation Tax before R&D tax credit claim: £0
£100,000 x 130% = £130,000 (uplift)
(£300,000) – £130,000 = (£430,000) (loss after deducting profit)
£100,000 x 230% = £230,000 (maximum losses to surrender to HMRC)
The company can either carry the additional loss forward to be offset against future taxable profits; or the lower of 230% of qualifying expenditure or revised loss for the period can be surrendered to HMRC in exchange for a cash tax credit @ 14.5%.
If losses were surrendered, SME #2 would receive:
£230,000 x 14.5% = £33,350
£33,350 approx. 33% saving from R&D tax credits and carry forward (£200,000) to next year
A claim for loss-making companies can be complicated, but we have experience in exposing the details to ensure that our clients get the maximum benefits from their claim. If you fall into this category, we can help you – speak to our advisors today.Speak to a member of our team
Factors that can affect R&D tax credit claims
Your R&D tax credit claim can be affected by anything that causes your R&D expenditure to be enhanced, as any enhancements can affect which schemes you qualify for. We have found that the following are factors that companies need to consider before submitting a claim.
It is possible to claim R&D tax credits on subcontractor costs which is usually 65% for SMEs; however, when it comes to subcontracting there are different rules that apply and the definition of what counts as subcontracted work can be very specific. For those companies who fall into the RDEC scheme, the subcontractor must be an individual, partnership of individuals or a qualifying body for the expenditure to be eligible.
Find out more about independent contractors and subcontractors and what you need to consider when including their costs in your R&D tax credit claim.
Grants and subsidies
Grants and subsidies are a great way to fund innovation and can work hand in hand with R&D tax credits. With savings of up to 33p for each £1 spent on research and development, the SME R&D Tax Credit scheme is the most generous state aid on offer, though when combined with grants its use may be restricted. Often, if a company has received grants or subsidies, they still qualify for the RDEC scheme, though it returns a lower rate than the SME scheme.
If you have received a grant to fund your R&D activity or are considering applying for one, it is important to speak to an expert who can offer advice on how to maximise your return on investment, because the type of grant that you apply for and the wording of the agreement could impact how much you could receive from your R&D tax credit claim.
Linked or Partner Enterprises
In some cases, you or your company may be linked to a partner or enterprise which can affect whether your company is deemed to be an SME and therefore eligible for the SME R&D Tax Credit scheme. If the below apply to your business, it is likely that your company would be classified as ‘linked’:
- the other company owns more than 50% of the voting rights
- they can appoint or remove a majority of your management team
- they can exert a “dominant influence” over your company
- they can indirectly achieve the above via agreements with other shareholders
Understanding whether you are ‘linked’ or not is important because if you are, your numbers would be aggregated with other companies, which may put you over the threshold for SME R&D Tax Credit scheme.
In situations where the company isn’t autonomous or linked, and a partner co-owns between 25 – 50% of the business, and cannot control the company, it is not considered to be ‘linked’ but considered a partner enterprise. In this case, you could still qualify for the SME scheme.
If you aren’t sure where you fit in, our team of experts can help you understand your position and the benefits available to you.
What do we do and how can we help?
R&D tax credit claims can be confusing and complicated, but with over 12 years’ experience, having secured over £210 million for our clients, we’re not new to HMRC or their requirements. Innovation is our business; with our industry experts and tax specialists we can identify the nuances of your project to uncover the technical value of your claim.
As with any concession, getting the most out of an R&D tax credit application takes a real understanding of how to present your innovations to HMRC and this is where expert knowledge of not just the tax, but the industry-specific technical elements becomes important. Speak to one of our advisors to see how we can help your business.Get in touch