R&D Tax Relief (SMEs)

If a company is a small to medium-sized enterprise (SME), tax relief may be claimed on a proportion of the expenditure on R&D activities.

SME classification

A company is an SME if it has:

  1. total staff of fewer than 500 people; and
  2. turnover of less than €100m OR balance sheet assets of less than €86m.

Connected companies may need to have their figures included for assessing SME thresholds. This is dependent on the connected company’s classification as either:

  • Autonomous: no external, corporate entity owns 25% or more of its shares and if it does not own 25% or more in any other company;
  • Linked: are able to exercise control over the affairs of the other via usually through holding greater than 50% of company voting right;
  • Partner enterprises: are not linked, but enterprise holds between 25% and 50% of voting rights.

SME definition

What costs qualify for R&D relief?

  • Staffing costs, including gross salaries, wages, overtime pay and cash bonuses; employer NI contributions; and employer pension contributions.
  • Payments to a subcontractor to carry out activities that are part of the company’s R&D. The subcontractor’s activities need not be R&D when considered in isolation, as long as the activities are part of a larger project that is R&D. Subcontracted analytical testing, for example, may qualify for relief. Only 65% of the total subcontractor costs can qualify for R&D relief, and relief may be available where the subcontractor is outside the UK.
  • Costs of externally provided workers (EPWs), which are the staff costs paid to an external agency for staff who are directly and actively engaged in the R&D project. EPWs must carry out R&D activities under the supervision, direction, or control of the claiming company. Only 65% of the total EPW costs can qualify for R&D relief.
  • Consumables, which are materials that are consumed or transformed in the R&D process. These include utilities such as water, fuel, and power.
  • Software, including the cost of software licences utilised in the R&D activities.

How are benefits calculated?

SME R&D relief allows companies to:

  • Deduct an extra 130% of their qualifying costs from their yearly profit; and
  • Claim a tax credit if the company makes a loss, which is worth up to 14.5% of the loss that can be surrendered.

For companies making a profit:

SME R&D relief allows companies to deduct an extra 130% of qualifying costs from their profit for tax purposes.

Trade profits = £1,000,000
Corporation tax (CT) liability @19 = £190,000
     
Qualifying R&D expenditure
=
£100,000
Enhanced deduction @130% = £100,000 x 130%
  =
£130,000
     
The enhanced R&D deduction is subtracted from company trading profits:
Trade profits less R&D  = £1,000,000 - £130,000
  = £870,000
Revised CT liability = £870,000 x 19%
  = £165,300
     
CT saving:    
CT saving: = CT liability – revised CT liability
  = £190,000 - £165,300
  = £24,700
     

The net benefit is therefore £24,700, or 24.7% of the qualifying R&D expenditure

For companies making a loss:

SME R&D relief allows companies to:

  • Deduct an extra 130% of their qualifying costs from their profit; and
  • Claim a tax credit worth up to 14.5% of the loss that can be surrendered.

The amount of the loss that can be surrendered is the lesser of:

  • The amount of the unrelieved trading loss sustained in that period; and
  • 230% of the related qualifying R&D expenditure. That is, the business can receive a credit not only for the uplift, but also for the initial expenditure.
Trade profits  =
-£1,000,000 (a loss) 
Corporate tax liability @19%  = £0
Qualifying R&D expenditure  = £100,000
Enhanced deduction @130%  = £100,000 x 130% 

 

= £130,000
The enhanced R&D deduction is subtracted from trading profits. Revised trading profits SME R&D relief allows companies to surrender losses in exchange for a cash credit.
The cash credit is 14.5% of the loss that can be surrendered, which is the lesser of:

  • unrelieved trading loss in the period
    and
  • 230% of qualifying R&D expenditure




=

=




(£1,130,000)

(230% x £100,000 = £230,000)
R&D tax credit   = Cash credit rate x 230% x qualifying R&D expenditure 
   = 14.5% x £230,000 
   = £33,350 

The net benefit for the company is therefore £33,350.

This equates to 33.35% of the qualifying R&D expenditure and is more generous than R&D relief for profitable companies

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Justin Arnesen

Partner, R&D Tax and Government Grants, Business Tax

Business tax
London

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