The same, of course, applies to firms looking to progress an idea that could revolutionise how they work. Their due diligence relates to aspects of whatever it is they want to progress – market, materials, pricing and so on.
But this can prove rather expensive.
Helpfully, for those wanting to research and develop a project which involves science or technology, HMRC, through research & development (R&D) tax credits, can take some of the financial pain out of the process.
However, there are not only hoops to jump through but a nasty potential sting in the tail for those that break HMRC’s rules.
A brief history lesson
R&D tax credits were first launched for SMEs in 2000 by the Labour government under chancellor Gordon Brown. Through the incentive, the government wanted to show that the UK was a world leader in innovation.
Very simply, R&D tax credits offer a reduction in corporation tax and/or a payable credit to those SMEs that implement research and development projects within their organisation; they were introduced as a way for SMEs to increase the percentage of GDP being spent on R&D from 1.7% to 3%. A separate but similar incentive for larger companies, called R&D expenditure credit (RDEC), was established in 2002.
As Emma Rawson, technical officer at the Association of Tax Technicians (ATT), details, R&D tax credits have become increasingly popular. She highlights that in tax year 2021-22, around £7.6bn of R&D tax relief was claimed, an increase in 11% on the previous year.
However, she says that R&D tax credits have also become something of a victim of their own success: “The increasing cost to the Exchequer and fears around abuse and fraud led to changes being made. Consequently, the level of support available to SMEs reduced in April last year (2023) and new, stricter compliance requirements have been introduced with even more radical changes following from April 2024.”
Target market
As to who they’re aimed at, Rawson says that “R&D tax credits are intended to be claimed by companies carrying out genuine R&D as part of their trade”. She adds that “the definition of R&D for tax purposes is fairly wide – it’s not just lab coats and test tubes”. This means that some activities may be classed as R&D might not have been expected to on first glance.
Nigel Holmes, director, research and development at funding advisor, Ryan Innovation Funding, explains that R&D tax relief is open to any company investing time and money in new products or processes that meet HMRC’s definition of R&D. He says that this means that “any company of any size whose work seeks a ‘scientific or technological advance for their industry’ and has tried to resolve a ‘scientific or technological uncertainty’ can claim”. And there is no minimum value required to use the regime.
But to count as R&D, Rawson says that the advance has to be in the overall field, not just for the company conducting the R&D. There also has to be some element of scientific or technological uncertainty – if the answer to the problem is already known, it won’t count for tax purposes as R&D. This means that taking something that is common knowledge and applying it to a business won’t be R&D, unless there is some real uncertainty to the underlying science or technology.
Similarly, she says that “routine copying, analysis or adaptation of something that already exists isn’t R&D”. She also warns that “if you’re only making minor tweaks to an existing process or product you won’t generally be able to claim.”
Holmes offers more detail, noting that the SME scheme is open to smaller companies with fewer than 500 employees and either under €100m turnover or €86m assets on the balance sheet. (The limits are in euros because the HMRC rules were adapted from Europea-wide rules.) The Research and Development Expenditure Credit (RDEC) is for larger companies or smaller companies that don’t qualify under the SME scheme because of subsidies such as grants or because of acting as a subcontractor.
It’s also worth knowing, as Holmes explains, that while “a company must be seeking a technological or scientific advance within its industry, it’s important to note that this does not have to lead to a successful project that becomes operational, nor does it have to be a completed project.”
He continues: “Qualifying claims can cover new processes, products, or services, or be an improvement to an existing one.” Further, he notes that claims commonly include the cost of staff, materials, software, subcontracted services, data licences and cloud computing.
And Rawson agrees, saying that it needs to check that it has qualifying expenditure: “Not everything spent will qualify… and this can all be very complicated, so if you’re unsure it’s best to take professional advice from a reputable R&D specialist.”
How the incentives work
In terms of the SME scheme, Rawson says that companies can deduct 186% of their qualifying R&D costs from their Corporation Tax bill; if they are loss-making, they can surrender some of that loss for a payable tax credit worth 10%. The SME scheme is therefore very attractive, as it can result in a cash payment from HMRC.
Holmes says: “This can be highly rewarding for innovative companies, and many use the relief to grow their business, invest in more R&D, and hire more staff.” But he draws attention to the fact that the scheme has recently become less rewarding for SMEs.
In essence, for SMEs with expenditure after 1 April 2023, the additional uplift rate on tax relief fell from 130% to 86% and the tax credit rate dropped from 14.5% to 10%. However, SMEs defined as ‘R&D intensive’ will still retain the 14.5% R&D tax credit relief rate, as opposed to the 10% rate for loss-making SMEs. R&D-intensive SMEs are those where 40% or more of their companywide tax-deductible expenditure relates to qualifying R&D spend for the given period.
Meanwhile, the rate under the RDEC scheme for larger companies and SMEs in receipt of grant funding increased from 13% to 20%. At this point Rawson comments that the RDEC scheme works a little differently. Under RDEC, the company receives a taxable ‘above the line’ credit which can then be set against their tax liabilities. If there are no tax liabilities left to offset, the credit can sometimes result in a cash payment to the company.
Rawson also says that the two schemes have been merged for accounting periods beginning on or after 1 April 2024, which will see companies of all sizes falling into an RDEC-like scheme.
Abuse of the system
The problem with any tax regime that offers lower tax bills, or even the return of cash, is that it’s a readymade target for abuse. And as Rawson knows, R&D tax credits, and the SME scheme in particular has seen growing abuse in recent years which has reached a worrying level. She says that “this ranges from out and out fraud – such as companies set up just to claim credits, with no R&D taking place, to abuse and boundary pushing where claims are made for activity or expenses which really aren’t R&D”.
She cites research published last year in which HMRC estimates that the overall level of error and fraud across both schemes was 16.7% or £1.13bn, and in the SME scheme was as high as 24.4% or £1.04bn.
Holmes, meanwhile, refers to data that estimated that R&D tax relief fraud reached £469m from 2021 to 2022.
These numbers have been driven by fraudulent claimants. Specifically, Rawson knows that the actions of “‘rogue’ R&D agents who aggressively target taxpayers, convincing them to make claims which are either not valid or incorrect, usually in exchange for a cut of any repayment received” are a key part of the abuse.
From her perspective, “the problem with these rogue agents is that often, by the time HMRC catches up with them, they will have closed down and moved on, leaving the company that claimed out of pocket and with nowhere to turn.”
It should be said that HMRC has doubled the numbers working in R&D compliance in the last three years and now has a dedicated anti-abuse unit. The tax authority estimates this has led to it blocking £85m in fraudulent claims, challenging more than 2,500 suspected claims, and the arrest of nine people.
However, Rawson says that HMRC still doesn’t have the resources to look into every single claim. She thinks that the introduction of new reporting requirements such as the additional information and claim notification forms (detailed below) is “an attempt by HMRC to work smarter: getting more information should help it target compliance activities, as well as putting off some fraudsters”. However, it also means more hoops for genuine claimants to jump through, and failure to submit additional information or claim notification forms when required “could lead to them missing out on relief they are otherwise entitled to.”
The government, says Rawson, is also hoping that moving all companies to a single RDEC-like scheme will reduce abuse as the SME scheme seems to be particularly attractive to fraudsters.
And for Holmes, HMRCs “crackdown on abuse of the scheme is important because innovating companies are only properly rewarded if tax credits go to those truly breaking new ground”. He thinks that “if companies who don’t deserve the relief are receiving significant sums, it erodes the financial advantage that should only belong to those making genuine claims”.
How to claim
It’s precisely because of the rising level of abuse that HMRC has introduced new measures which require all claims to be submitted digitally.
Introduced last year, Rawson says that firms need to be aware of the changes or else they may not be able to claim. She says that firms must now submit detailed information before they can claim R&D tax relief. Claims will be rejected otherwise. The form asks for detail about not just the company, but also why claimants think they have been carrying out R&D and the expense that has been incurred.
In addition, for accounting periods from April 2023, those that have never claimed R&D tax credits before, or haven’t claimed in the past three years, will need to tell HMRC that they are planning to make a claim. An online claim notification form, ‘Tell HMRC that you’re planning to claim Research and Development (R&D) tax relief’, needs to be submitted within six months of the end of the accounting period, or else firms won’t be able to claim for that period at all.
Notably Rawson says that HMRC’s approach to processing R&D credit claims is generally to pay now and ask questions later. She says that “whilst this means you may receive your tax credit payment relatively quickly, be aware that this doesn’t mean HMRC has ‘accepted’ the claim, and they could still look into it at a later date.
“If HMRC then decide the claim was incorrect, they will expect you to pay it back, potentially along with interest and penalties.”
Even so, Holmes reckons that the recent and upcoming changes, particularly the requirement to notify HMRC in advance about the intention to claim, “will be particularly challenging for SMEs to navigate”. He adds: “If they are not up to speed with the legislation, and do not know they need to pre-notify HMRC, they are at risk of missing out on money to which they are entitled.”
Advice for claimants
Many areas can trip up companies claiming for the first time. From the viewpoint of an insider, Holmes knows that “the very definition of R&D is complicated, and understanding the differences and nuances of the different schemes can be confusing”.
Beyond that he also knows that “it can be difficult for companies to work out which costs qualify and so do the appropriate calculations”. He gives an example: the amount of qualifying staff costs that is based on the proportion of time spent by each of the R&D staff on the projects during the claimable period. HMRC considers that staff normally carry out some non-R&D activities, so care should be taken when determining the time apportionments, as 100% may not be seen as feasible.
From a different standpoint, Rawson reiterates the need to seek advice from a reputable specialist to make sure the claim is valid and that all supporting information that is needed is to hand.
In particular, she says that “when it comes to choosing an adviser, there are lots in the market place, and it can be hard to identify who to trust. The ATT has produced some guidance on what to look for in an R&D adviser that is free to access.” This, for the record is on att.org.uk under Choosing a Specialist Research and Development (R&D) Tax Adviser. You can find it here.
However, one thing Rawson says to be particularly aware of is whether the marketing looks too good to be true: “Any firm claiming they are ‘HMRC approved’ or have a ‘100% success rate’ should be treated with caution.”
As to what to do if applicants have been refused the credits by HMRC, there is little option but to enter into an argument with HMRC, something which Rawson reckons is becoming more protracted and costly over time.
She advises that “if you are convinced you have a genuine claim, you can ask HMRC to review their decision, or even appeal to the tribunal. However, you should be aware that all of this comes with a cost, so you may want to weigh up the pros and cons before proceeding, especially if your claim is relatively small.”
Holmes takes the same line and states that HMRC is being more aggressive with its challenges on R&D claims: “We recommend that companies keep pushing, and if the case is rejected, seek a second opinion from HMRC. The next stage is alternative dispute resolution (a form of mediation) or ultimately an appeal through to a tribunal judge.” Like Rawson, he knows this process to be costly and time consuming.
He also recommends that if using a specialist, “make sure you find one who will support you through an appeal. We stand by every single claim we have submitted and will support clients throughout the entire process”.
It does appear, though, that some companies do end up walking away from what they believe to be a genuine claim, just because of the time and effort involved in fighting their corner.
Summary
R&D tax credits have a distinct goal in mind and for those wanting to genuinely progress a scientific or technological development, credits can make the costs – of failure as well as success – much less punitive. The key, however, to navigating a complex regime is good advice.
CASE STUDY
Designs Signage Solutions
Hull-based Designs Signage Solutions (DSS) received £100,000 in R&D tax relief from the government for its work in creating sustainable event signage and developing 3D scanning to improve how its designs fit to surfaces.
Announced in August (2023), the company said it had made an advance in technology and manufacturing through the development of sustainable event signage that is easier to store, reuse and recycle.
Rob Daysley, managing director, says that he was first drawn to R&D tax credits by his accountant who subsequently sourced a consultant, Catax (the former trading name of Ryan Innovation Funding) to assist with the claim. He says: “Our accountant said ‘I think that with the amount that you do there’s an opportunity for you to get a little bit of help with relief on the tax.”
More than five years later and DSS now has a partnership with Ryan where “they understand us as a business, and we understand them”.
DSS, says Daysley, has faced many challenges over the past five years and many are still ongoing. They were, he says, “around manufacturing and production and breaking into new markets… we’ve used [R&D tax credits] for many things - some successful, some unsuccessful”.
On this Daysley explains that “it helps us progress and into different areas. it’s helped us move forward quicker and explore new areas”. Interestingly, he thinks technical progression is “about failure - it’s not about success, and when you’ve got assistance from R&D tax credits it helps that we’re not so concerned about trying things that may not work out as we’ve got support”.
As to what R&D tax credits meant to the company, Daysley comments that “the benefits that we get from R&D we invest back into the company - what comes back financially goes straight back in and it helps the business grow”.
And in terms of how Catax was selected, Daysley says that the firm was recommended to DSS: “We did a bit of a ‘beauty parade’, if you like, from other suppliers, but we liked them.”
In operational terms, DSS was involved in the claim process and Catax “guided us through it with what’s eligible, what wasn’t and how we could do it”. He tells how others have since tried to win DSS’ R&D claims business “because R&D has become very prominent in the last few years - but they didn’t understand what we do” and so failed in their attempts.
On a practical level Daysley says that Catax helped with the application and keeps the company in tune with current legislation “because it changes all the time”.
Ultimately, he is of the view that R&D tax credits are beneficial “if they’re used in the correct way and how they’re intended to be used”.
