How to better forecast an R&D Tax claim
Updated: Nov 2, 2022
For R&D projects, the amount a business can claim ranges anywhere from 0 to 33%, depending on several interconnected factors. If you have clients that are investing in research and development activity, and making R&D tax relief claims, it’s important for them to have as much certainty over their R&D claim, as early as possible, even as early as the planning phase. But Why? Well, an R&D claim only gets money back for costs that have already been incurred. This means the business doesn’t get any benefit from the investment until at least a year or so down the line, or if they’ve really got their act together, several months.
Getting a better understanding of what will qualify before an R&D project allows businesses a more accurate estimate of the true cost of the investment at the outset. At the front of the project this enables more accurate budgeting for the time and resource invested. And at the back of the project when the claim comes to realisation, this enables more accurate cashflow forecasting so they can plan for any potential future investment.
So, what is the true cost of R&D?
It’s important for clients to understand the fundamentals if they want to understand the true cost of their R&D investment. So, here’s a few key areas they’ll need to get grips with before kickstarting their next R&D project. Share this information with your R&D clients and help them get ahead of the game.
Is it even an R&D Project?
It sounds obvious but you’ve got to get past this hurdle first and believe us when we say we still work with businesses that misidentify R&D projects all the time. To err on the side of caution it’s best to keep a record of all projects that could qualify and just get it checked out with an R&D specialist.
As a helpful reminder, to be eligible, an R&D Project must be: Making a considerable improvement to existing technology. This doesn’t always mean it needs to be ground-breaking work. If a business is working to overcome technical uncertainties in order make their products, services or processes, faster, less expensive, or better in some way, then this may be eligible for R&D tax relief.
Overcoming technological challenges, where the solution is not readily apparent to a qualified professional.
If it’s an R&D project, then it goes on the list, to determine what costs can be claimed.
What costs can be claimed?
It’s always good to get a recap, and the categories are….
Staff costs Salaries, pensions and NIC of staff who are directly involved in the R&D project.
Reimbursed expenses paid to employees or directors on R&D travel Reimbursed expenses claimed by employees or directors on travel related to the R&D project.
Outsourced subcontractors or freelancers 65% of the costs paid for "unconnected" subcontractors (under the SME R&D scheme).
Materials for prototype builds The cost of the materials required for designing and constructing a prototype which will not be sold.
Ancillaries - utilities, software licences An appropriate proportion of utilities and software costs used in R&D projects.
But it’s tax and it’s never that simple….knowing whether the activity ACTUALLY fits into a qualifying category can throw up some tricky red herrings! Software and Hosting….
Now this one’s a little cheeky. Software licences can be claimed. But hosting costs on their own do not fit into a qualifying category of R&D. This can be frustrating as businesses often incur large hosting costs used purely for R&D, so they should be include…but currently they aren’t.
Hosting can often include a lot of services, and depending on how the company uses them, there is the possibility they could be eligible under the software licence header. A specialist is really needed here to help apportion the amount linked to a qualifying category. Storage, telecom and data costs are just out of the game, they do not qualify.
Staff time… Time allocation for employees involved in R&D projects will often be one of the biggest costs, and so it is vital to apportion everyone’s time as accurately as possible to get better certainty over the R&D claim. Record time spent by those directors, employees, qualified staff working on the R&D project. It’s also important to make sure staff costs are included for all indirect qualifying activity. This includes roles of support staff where they are engaged in activities such as finance and HR, that indirectly support an R&D project.
What rate will apply?
So now we know the project is eligible, and the different qualifying categories our activity slots into (including the nuances), we want to know the R&D rate applied to the activities.
Here’s three main factors that could impact the amount of the costs incurred that can be claimed back:
R&D SME vs. RDEC Scheme Depending on which scheme is being used, it can significantly impact the rate of the claim.
RDEC SCHEME: Following the 2021 Budget, RDEC increased to a 13% tax credit for expenditure incurred on or after 1 April 2020. As RDEC is subject to corporation tax, the net of cash benefit is currently 10.53%
SME SCHEME: The SME R&D Scheme is currently an additional 130% tax deduction for qualifying expenditure. So this equates to a 24.7% cash benefit for profitable companies, and up to 33.35% cash benefit for loss making companies that can claim the SME “tax credit”. Also note that following the 2021 Budget, SME tax credit claims are now subject to an annual cap of £20k plus 300% of the company’s PAYE and National Insurance Contributions liability.
The other major difference with the RDEC scheme is that you cannot claim for costs paid to limited company subcontractors.
Subcontracting vs. Inhouse
If a company sub-contracts R&D work to a third party subcontractor (unconnected to the company) – they will still be able to claim for some qualifying costs but the relief may only be 65% of those costs.
NOTE. If a company has taken on subcontracted R&D work into their business, they might not be able to claim R&D tax relief at all, or the only route available is under the RDEC scheme – reducing the claim to 10.53% of the qualifying expenditure.
Profit Position vs. Loss Position The upfront cashflow benefit is actually greater for loss-making SMEs. Here’s the numbers:
Loss: If a company is going to be in a loss position, then HMRC will make a cash payment of up to 33.35p for every £1 spent on R&D activities.
Profit; If a company is going to be in a profit position then HMRC will make a cash payment (or offset against your corporation bill) of up to 24.7p for every £1 spent on R&D activities. Then timings come into play…. Loss: If a company is going to make a loss, they can make the claim as soon as the accounts are prepared and ready for filing.
Profit: If a company is likely to be profitable, it’s a little different. The biggest benefit will come by reducing the tax bill which is due 9 months after their year end.
R&D for Financial Forecasting
As you can see there’s actually a lot to consider when it comes to forecasting an R&D claim. But any steps a business can take towards getting a more accurate idea of their R&D claim in advance of the project are worthwhile.
For businesses that already claim R&D tax relief, they should be able to retrospectively use the information from their previous claims to help navigate some of the more challenging nuances of R&D tax relief. It’s win win.
Get in touch
For DTX’ers with a potential R&D Tax Relief client you’d like to discuss please book a scoping call here.
Radish Tax by Diagnostax is a specialist R&D Tax Relief provider. Find out more about Radish Tax by Diagnostax.