It is a purely technology/science based question as to whether or not a project will qualify and the scheme provides relief for each pound of qualifying R&D expenditure.

There are different rules for SMEs and large companies. The rates changed in August 2008, April 2011 and April 2012 which means that for R&D projects carried out that cross time periods with different  rates, an apportionment should be carried out. Additionally, the SME scheme now applies to companies with up to 500 employees.

The incentive provides an extra tax deduction based on R&D spending.  For certain loss making small or medium sized companies (SMEs) it may be possible for them to surrender their losses in return for a cash payment from HMRC.

  • SMEs can deduct up to 200% of qualifying expenditure (225% from 1/4/2012) on R&D activities when calculating their profit for tax purposes. In certain circumstances, SMEs can surrender this tax relief to claim payable tax credits in cash from HMRC if they have losses in the accounting period.
  • Large companies can deduct up to 130% of qualifying expenditure when calculating profit for tax purposes. Under this regime, there is no credit repayment available in the case of losses in the accounting period - the uplift simply increases the losses available for use.

There is also a capital expenditure scheme (R&D Allowances or RDAs) for both SMEs and large companies. This allows for a 100% reduction of qualifying capital R&D spend in the year of expenditure. The rules about what qualifies for RDA claims are broader than for revenue expenditure claims.

What R&D activity qualifies for the incentive?

The definition of qualifying R&D activity is wide-ranging and sometimes challenging to apply in practice. HM Revenue & Customs (HMRC) and the Department of Trade and Industry (DTI) have issued guidelines to help companies identify their eligible activity.

The activity has to be for a project that attempts to:

  • advance the level of knowledge in a field of science/technology and
  • resolves scientific or technological uncertainty.

This is a very broad definition and it should be born in mind that:

  • Only part of a project may be thought of as 'difficult' R&D but frequently large routine elements will also qualify if they are essential to proving the R&D
  • You do not need to share that information with anyone else in the industry
  • Success of the project is not essential
  • For the Large Company Scheme, you can be doing the work for someone else

What R&D costs are eligible for the incentive?

There are four main categories:
  • Staffing costs - salary, national insurance costs, pension contributions
  • Consumable and transformable materials - materials consumed/transformed in the R&D process, software used directly in the R&D and limited overhead payments for power, fuel and water.
  • Externally provided workers - agency staff and workers provided by group employment companies.
  • Payments to qualifying bodies/contributions to independent R&D efforts.

There are also detailed rules around sub-contracting for the SME regime and important differences in effective dates for some categories of expenditure.

What do I need to think about when approaching an R&D tax relief claim?

There are three main areas to think about:
  • Project qualification - You need to identify your main R&D experts, or as they are defined by the legislation; 'competent professionals working in the field'. You should utilise the knowledge of these staff and involve them in the process of deciding which of your projects and the activities within them qualify and documenting why.
  • You need to be able to back up these decisions with satisfactory documentation both so that HMRC can be sure that its guidelines are being adhered to
  • A clear, effective methodology to support your R&D professionals in their decisions can help you develop best practice within your organisation and ensure that you remain compliant with HMRC legislation.

Cost quantification & HMRC liaison

You'll want to identify as much eligible expenditure as possible providing it is cost-effective to do so and will need to map costs in the qualifying categories (salaries, consumables, etc) to the eligible activities identified.

In doing so, it's important to balance your approach with the associated administrative burden of justifying the claim. It may not be cost-effective to look at every project and considering a sample-based approach where there are a large number of projects is common practice. The methodology you use for quantifying costs should suit the form of your R&D organisation and use the data available from existing reporting systems  wherever possible.  In addition, your process should be repeatable on an ongoing basis, providing certainty for future years and ensuring a claim can be made easily within an agreed framework with HMRC.

Dealing with HMRC is a key part of a successful claim process. Depending on the company size, number of projects, and the approach being taken in preparing a claim, it may be better either to agree an approach with HMRC  at the outset or alternnatively to present a completed claim to them in its entirety. You need to be confident that your claim approach is robust and communicate this effectively to HMRC.