Research and development continues to be a highly relevant and topical area in the world of corporation tax. The UK is unusual internationally in operating two R&D schemes with the newer, large company ‘above the line’ research and development expenditure credit (RDEC) available alongside the SME scheme.
These research and development relief schemes are designed to provide financial support to UK companies engaging in innovative work in the fields of science and technology. Government statistics indicate that around 60,000 companies avail themselves of these reliefs annually, claiming an estimated £5.3bn. Such companies, and the solutions they create, are seen as key drivers of economic growth. In support of this growth, the Government has a stated target of increasing UK investment in R&D to 2.4% of GDP by 2027.
Balanced against this drive to increase spending on R&D however, Government is also continually seeking to ensure that the reliefs available remain effective and are not open to abuse. We are accordingly seeing a regular series of announcements or legislative changes in the R&D tax relief space; on the one hand providing incentives encouraging companies to invest, and on the other ensuring that those companies claiming reliefs are doing so legitimately.
Definition of R&D
For tax purposes, HMRC define R&D as taking place “when a project seeks to achieve an advance in overall knowledge or capability in a field of science or technology”.
The concept of uncertainty is key in relation to this definition. The activity must overcome a problem that has not been resolved before and would not be readily soluble by other professionals working in the field. Accordingly, a project that fails can still qualify for relief, and indeed evidence of previous failures will commonly be a hallmark of genuine R&D activity.
Similarly, the concept of uncertainty also defines the start and end of an R&D project; the project starts when work to resolve the uncertainty commences and ceases where that uncertainty is resolved. A particular project of a business may therefore fall in and out of this definition according to phases of the project where uncertainty was present.
Where a project does meet the definition of research and development, certain defined costs incurred by the business will qualify for relief. The most common form of qualifying expenditure will be staff costs, both direct and externally provided. In addition, expenditure incurred on software or consumables, and relevant payments to the subjects of clinical trials will also qualify. Certain costs will never be qualifying, such as capital costs (although 100% capital allowances may be available under CAA 2001 Part 6). In terms of “qualifying expenditure”, the RDEC rules largely borrow the same legislative definitions included under the SME scheme.
There is a significant degree of interpretation and judgement required in determining which projects and cost meet this definition of R&D and an industry of boutique firms has arisen specialising in providing analysis services for companies, often geared towards their appetite for risk. HMRC provide an advance assurance service for SMEs to help provide certainty.
Definition of a large company
A large company is defined under CTA 2009 s1122 as a company that is not a small or medium-sized enterprise. A small or medium-sized enterprise is defined under s1119 by reference to the European Commission definition included in Commission Recommendation (EC) No 2003/361, qualified by s1120 which doubles each of the limits.
The resulting tests are that a company will be deemed to be an SME where it has:
- Fewer than 500 employees, and
- A turnover not exceeding €100m, or
- A balance sheet value not exceeding €86m.
Aggregation rules apply – see the concepts of autonomous, partner or linked enterprises discussed at HMRC manual CIRD91500 – which, as well as groups of companies generally, may be of relevance to investing companies such as venture capitalists.
Large company RDEC scheme
A company that is defined as large is obliged to use the RDEC scheme under CTA 2009 Part 3 Chapter 6A. This scheme may also be used by SMEs undertaking subsidised or sub-contracted expenditure.
This scheme was introduced by Finance Act 2013 with effect from April 2013 and replaced large company rules within the SME scheme which, after a three-year transitional period, were withdrawn from April 2016.
This legislation provides for a taxable credit to be brought into account – referred to as “the set-off amount” – which is calculated at 13% of qualifying expenditure. This rate has been steadily increased by past Finance Act changes having initially been set at 10% when the scheme was introduced in 2013.
The RDEC scheme is referred to as “above the line” on the basis that this taxable credit may be accounted for in the profit and loss account, thereby increasing profit before tax and making the relief visible to users of company accounts.
For tax purposes, relief is then provided for this credit in accordance with a 7 step calculation laid out under s104N. Step 1 sets the credit against any corporation tax liability of the accounting period, and step 7 ultimately allows for the credit to be paid in cash to the company. Step 3 includes a limit to the company's total expenditure on workers to ensure that this payment is only available to companies with a genuine economic presence in the UK, and along with Step 2 – which is a restriction to the net value of the set-off amount – can create carried forward amounts.
The SME scheme comprises CTA 2009 Part 13 which includes two main features. The first is an additional deduction of 130% of qualifying expenditure on R&D when drawing up profits of a trade. With the corporation tax rate presently at 19%, this relief equates to a tax saving of 24.7%. The second is a 14.5% tax credit which is available for companies with a surrenderable loss. This credit discharges any liability of the company to pay corporation tax in the first instance, and then is payable to the company.
A company is prohibited from claiming under both the RDEC and SME scheme in respect of the same expenditure by CTA 2009 s104B.
Refer to HMRC manual CIRD80000 for further background to the SME scheme.
Research and development reliefs are claimed as part of the company tax return process. The following boxes on the form CT600 are relevant:
- Box 530 – Amount of Research and Development credit taken into account as part of the calculation of tax outstanding or overpaid.
- Box 660 – Amount of R&D enhanced expenditure as uplifted by the 130% additional deduction.
- Boxes 875 and 880 – Amount of the credit under either the SME or RDEC scheme.
Latest developments for Spring 2021
New supplementary form CT600L
April 2021 saw the introduction of the new supplementary form CT600L by HMRC:
This supplementary form must now be completed for any new or amended company tax return submissions which include an R&D tax credit. Whether a return includes an R&D tax credit is effectively defined by whether box 530 or box 880 are completed on the main form CT600, although the way in which these boxes are populated is now defined by the CT600L itself.
The form CT600L comprises 46 boxes across four pages and is primarily aimed at the large company RDEC scheme, presenting an extended series of boxes beginning with qualifying expenditure and working through the details of each of the 7 steps of relief outlined under CTA 2009 s104N, also reconciling any amounts carried forward or surrendered to group companies.
The SME scheme is represented though only though a handful of boxes on the last page which relate to surrendering losses for a tax credit; the 130% additional deduction is not captured on the form (but refer to box 660). Furthermore, in accordance with the rules defined on the face of the form and the associated e-filing validation rules, box 530 – Research and development credit – is no longer populated for most SME tax credit surrenders. This box is now only used where the credit is offset against any “other liabilities”, such as loans to participators charge, CFC charge, bank levy or surcharge, or ring fence supplementary charge (boxes 480 to 505).
The way in which box 530 was populated previously caused confusion for taxpayers in some circumstances as for RDEC in particular, the effect on the resulting corporation tax liability outstanding did not match reality. The introduction of the CT600L has changed the way in which this box is populated, but it initially appears that removal of any previous confusion has been replaced with new.
Thankfully though there were no legislative changes associated with the introduction of this form and so businesses involved in R&D claims should already be familiar with the terms and flow used, and software providers should have largely been able to automatically complete this form on behalf of their clients from existing structures.
There have been a small number of teething issues with the form however, with the initial e-filing validation rules not allowing for the boxes to be completed in line with the legislation where either Step 2 or Step 3 amounts were brought forward. These issues were addressed by HMRC in a further update to their e-filing service in May 2021, and taxpayers affected were advised to avoid e-filing until the issue had been resolved.
SME tax credit re-introduction of cap
First announced at Budget 2018 – and following two periods of consultation and draft legislation being made available during 2020 – Budget 2021 confirmed the re-introduction of a cap on the amount of any R&D tax credit available upon the surrender of losses under the SME scheme.
The existing tax credit is provided under CTA 2009 s1058 and is paid at 14.5% of the losses surrendered. A cap on this credit is to be introduced as a new subsection (1)(aa), operating in the same place and in the same way as a cap previously applied until being repealed by FA 2012. On a similar but more generous basis than before, the new cap is to be given as the sum of £20,000 plus three times the company’s “relevant expenditure on workers” for the payment period. This expenditure is defined by reference to the company’s total PAYE and NIC liabilities, with rules allowing for, but not double-counting, expenditure incurred by related parties. An exemption from the cap is provided for companies creating or managing relevant intellectual property and who met certain conditions under a new s1058D.
The new cap will apply for accounting periods beginning on or after 1 April 2021.
Transitional rules for straddling periods were included in the original draft legislation but have been dropped for the version included as Schedule 3 in Finance Bill 2021. This is an unusual approach for the introduction of corporate tax changes, but a pragmatic and welcome one which will remove an unjustifiable layer of complexity for businesses for these periods.
This measure is being introduced with the intention of preventing fraudulent or abusive claims being made by companies with very little substance in the UK. As such, companies undertaking genuine R&D should not be impacted in respect of the credit available to them. Companies claiming a credit however will now have the additional step of being required to calculate their relevant expenditure on workers figure with a suitable degree of accuracy for the tax return, even though the quantum is likely to have no effect.
R&D Tax Reliefs consultation
Also announced at Budget 2021 was a consultation into the existing R&D tax reliefs generally, with “the objective of ensuring the UK remains a competitive location for cutting edge research, that the reliefs continue to be fit for purpose and that taxpayer money is effectively targeted”.
Several organisations have raised scepticism over the effectiveness of the schemes in recent years. The Labour party consolidated some of these findings in their Funding Real Change policy paper of November 2019 – quoting a review by the Institute for Public Policy Research which estimated that “between 57 and 80 per cent of R&D tax credits are deadweight, subsidising spending which would have happened anyway” – and stated that they would “phase out R&D tax credits for large corporations”.
The CBI meanwhile has taken a different tack and called on the Government to widen the scope of R&D to include capital expenditure, big data and advanced analytics, outsourcing, upskilling and training.
The consultation document accordingly seeks to review the state of play or R&D reliefs, including asking: whether the schemes are effective in their aim; whether the rules should be consolidated; whether the definition of R&D remains appropriate, and; whether the rates or relief remain appropriate.
The consultation runs until 2 June 2021 and Government is inviting responses from “all interested parties and stakeholders”.
Like any initiative, R&D tax reliefs must evolve to keep pace with the changing world, or otherwise they will cease to be relevant. Both of the schemes presently operated in the UK have seen recent increases to headline rates aimed at encouraging uptake from businesses to boost productivity. At the same time though, the legislation and claims process are being tightened to ensure only genuine R&D benefits. The ongoing Government consultation is a strong indicator that further regulatory changes are to follow.