The UK has a reputation for being innovative and the Government has demonstrated its desire to keep that reputation by both funding through grants as well as tax relief. However, history demonstrates that when a legal tax incentive exists some clever person finds a way to exploit it. It is inevitable that HMRC will check a research and development claim. It is therefore important to have a supporting technical analysis for a claim, which will help prevent a time-consuming enquiry and provide peace of mind for the full entitlement of your tax credit.
A considerable number of companies don’t realise that they could have made a research and development claim. The scope for identifying R&D is huge and exists in every market sector. As knowledge has become more widespread about the availability of relief, claims have increased. HMRC’s report ‘Research and Development Tax Credits Statistics September 2018’ confirmed some 43,040 companies made relief claims in 2015/16 and at the time of the report 39,960 relief claims were made for 2016/17. However, 75% of claims made were worth less than £50,000, which could indicate that those claims are not taking into account all relevant activities or expenses.
The Required Analysis
Undertaking a comprehensive review and preparing a technical analysis identifies the expenses that are going to be the subject of a research and development claim and why they are necessary. The analysis should be prepared in a format to avoid significant HMRC scrutiny. It is important that the analysis is comprehensively undertaken to prevent a time-consuming enquiry that centres on the technology and whether or not it qualifies.
Sometimes it is even difficult to identify when the R&D activity started. It may be that the start of the activity occurred slowly and only after a period of exploratory work where plans were formalised to develop the idea. There is a restriction on how far back claims may be made and, as such, it is important to be proactive and not lose the opportunity.
A claim for R&D relief can be made for up to 2 years after the end of the accounting period it relates to. There could be a considerable amount of work to collate the necessary supporting information for a claim. It is no wonder there are so many potentially qualifying companies that haven’t made a claim: they are often resource restrained and their priority is elsewhere. The unfortunate reality is that unlocking the R&D relief could assist those companies greatly.
When making a claim, HMRC require supporting information. If the supporting information is a technically robust analysis by an appropriately qualified professional, it is likely the claim will be processed more quickly and without contention. HMRC suggest that the type of supporting information they require is to demonstrate that the R&D:
- looked for an advance in science or technology and aimed to achieve this advance
- had to overcome scientific or technological uncertainty
- overcame this uncertainty
- could not easily be worked out by a professional in the field
The analysis should be structured in a manner to demonstrate each of the above in suitable detail that is linked to the expenditure incurred. One of the significant costs could be employee and subcontractor costs. It will be important to consider their roles and activity in determining the costs attributable towards R&D. Many other costs will also require similar careful consideration.
It is likely to be necessary to identify and consider the project plan, timelines, commencement of R&D, any process issues, resource issues, skill availability, performance, product testing, governance issues, regulatory issues, procurement processes and issues as well as any difficulties raising funding. This process will inevitably require speaking with different team members as well as reviewing internal documentation and/or processes.
After an appropriate review is complete, an analysis can be prepared providing a breakdown of the qualifying R&D costs and supporting why they qualify beyond scrutiny.
The benefit is broadly the enhanced expenditure resulting in a lower tax liability, loss or, if chosen, a tax credit.
For example, to calculate the enhanced expenditure for an SME, it is necessary to:
- Work out costs directly attributable to R&D
- Reduce subcontractor or external staff provision to 65% of the original cost
- Multiply the total expenses figure by 130% to get the additional deduction
- Add the 130% additional deduction to the original R&D expenditure figure providing relief at 230%!
If the relief results in a loss, it may be surrendered for a tax credit:
|Original R&D expenditure||50,000|
|Tax credit @ 14.5%||16,675|
Bearing in mind the current corporation tax rate is 19%, the corporation tax saving on the original R&D expenditure would have been £9,500!
Potential areas where relief may be obtainable:
- Developing a new software
- Adaptation of premises and software development
- Developing a new material for use in engineering
- Creating new and innovative construction systems
- Modernisation and quality control improvements
- Integrating new technology with existing systems
- Adapting a product for a new market
- Creating new medical equipment
- Certain food produce developments
- Advancing eco-friendly technology
- Developing communications systems (for example in aeronautics)