Research And Development Tax Relief For SMEs: A guide
Research and development (R&D) is typically seen as an endeavour for large companies, but small and medium sized enterprises (SMEs) can foster innovation too. One of the best tools at your disposal to create new products as an SME? R&D tax relief.
In this article, we’ll answers the following questions:
- What tax relief is available to UK SMEs?
- How can tax relief help SMEs conduct R&D?
- Which companies can apply for SME R&D tax relief?
- What costs can you claim back?
- How you claim R&D tax relief with HMRC
How can tax relief help SMEs conduct R&D?
As we mentioned above, the majority of R&D in the UK market is conducted by enterprise size businesses. However, since the Government introduced tax reliefs for SMEs, the number of smaller firms conducting research is steadily increasing – figures from HMRC suggest the number of SMEs claiming R&D tax relief increased 7% in 2021 compared to 2020.
Costs of R&D are typically quite high. Businesses may have to hire new talent to undertake projects, while the typical lifecycle of R&D in the life sciences sector can be upwards of seven years. Smaller firms might not be able to conduct these projects, as it can eat into smaller profit margins, potentially creating losses.
To stimulate increased innovation in the country, without spending large chunks of the public purse on infrastructure projects, the government is therefore incentivising smaller businesses to pursue R&D.
It is a generous tax relief, and one that SMEs in sectors such as life sciences, pharmaceuticals, automotive, software, technology and food sciences should explore. After all, if your firm answers a question or creates a product that differentiates you in the market, it could stimulate massive growth.
What tax relief is available to UK SMEs?
SMEs can claim the following costs to cover their R&D budget:
- 130% of their qualifying costs from their yearly profit, on top of their typical 100% deduction, creating a total deduction of 230%
- claim a tax credit if the company is loss making, worth up to 14.5% of the surrenderable loss
What does this mean in reality? Well let’s use an example of a profitable business to illustrate potential savings.
|SME in profit||Before Enhancement||After Enhancement|
|Qualifying R&D Expenditure||£500,000||£500,000|
|Net Profit Before Tax||£4,000,000||£3,350,000|
|Corporation Tax Due||£760,000||£636,500|
|R&D Tax Relief||£0||£133,500|
As you can see, the potential savings in corporation tax are substantial, in this example, a profitable SME saves over 20% on their annual bill.
Which companies can apply for SME R&D tax relief?
SMEs can claim R&D tax relief if:
- they have fewer than 500 employees
- they have a turnover of less than €100m, or a balance sheet total under €86m
Businesses with external investment may not qualify. If you are a subsidiary of a larger business, this may disqualify you from being considered and SME. In such cases, HMRC may require you to provide the figures of your parent or connected company to establish if you are a genuine small or medium sized operation.
A connected company is defined as another operation which holds over 50% of your company’s voting rights, or vice versa.
A parent company is defined as an enterprise which holds more than 25% of your business’s capital or voting rights.
If you are already receiving another form of notifiable state aid for your project, you cannot apply for R&D tax relief.
You can claim certain costs on the project from the date you start working on it until you develop or discover the advance, or the project is stopped. These include:
Permanent employee costs: For staff that are working directly on R&D projects you can claim a percentage of their wages, salaries, National Insurance Class 1 contributions and pension contributions. If you have brought on a specialist HR or recruiter to build a project team, you can claim back these expenses, however administrative or clerical staff do not qualify.
External agency talent: If you need to bring in specialist staff from an outside organisation for the duration of a project, you can claim back 65% of the relevant payments made to the agency
Subcontractor costs: Again, up to 65% of costs can be claimed back
Other costs: Project specific software costs, consumable items such as materials and utilities, and the cost of paying for patients in clinical trials (a crucial expenditure for life sciences companies testing new treatments) can also be deducted
What costs can you claim back?
The following costs cannot be claimed:
- production and distribution of goods and services
- capital expenditure
- the cost of land
- the cost of patents and trademarks
- rent or rates
How you claim SME R&D tax relief from HMRC
You can claim for relief for up to two years after the end of the accounting period your project relates to.
The claim can be treated as a deduction from profits in your company’s tax return. The claim must be made in your return, or an amendment to the return.
You must send:
- a full Company Tax Return form (CT600)
- completed tax computation
- form CT600L
It is also worth noting here, how you must define the length of your project in order to qualify for R&D tax relief.
An R&D project starts when you begin a project aiming to resolve an uncertainty in your industry. As such, you must undertake prior research to make sure there is no other product or service on the market which already solves this problem.
The R&D activity ends once you have found a solution, or you have decided to halt the project. If this involves the creation of a product, this is defined as the moment you have a functional prototype that is ready to be put into production.
Want to know more about SME R&D tax? Get in touch
At Pennyhills, we believe in unlocking the potential of innovative businesses. If you want to know more about how we can free up your time, and your budgets, get in touch today.