I am constantly struck by life’s ironies, and one of my favourites is the fact that I, who was utterly useless at science and dropped all 3 of them at school as soon as I possibly could, am actively involved in helping companies to claim tax relief for research and development expenditure in the fields of science and technology. I suspect this would have amused my various long-suffering science teachers.
I say helping companies deliberately, because the various generous reliefs for R & D expenditure are not available to LLPs, partnerships or sole traders. I have no idea why this should be the case, but I am sure the DTI could enlighten me. Perhaps they reckon no one would be daft enough to undertake something as costly and speculative as R & D without limited liability, but that doesn’t explain the exclusion of LLPs.
What is R & D?
Let’s start with a nice easy question. A few pointers will suffice for this article rather than the complex definitions in the DTI guidance.
1. R & D involves a project seeking to achieve an advance in science or technology.
2. R & D activities directly contribute to achieving this advance by resolving scientific or technological uncertainty.
3. The advance must be in overall knowledge or capability in a field of science or technology, not merely in the company’s knowledge or capability.
4. R & D need not be successful for tax relief to be available.
5. Scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice, is not readily available or deducible by a competent professional working in the field.
6. Science is defined as the systematic study of the nature and behaviour of the physical and material universe, and technology as the practical application of scientific principles and knowledge.
What other requirements are there for tax relief to be available?
The R & D must relate to the company’s trading activities, either existing or intended to be derived from the expenditure.
The R & D expenditure must be revenue and not capital, which is our second easy question. In general terms, this means that the expenditure should not create an asset for the enduring benefit of the trade. Before you all shout “but why else would we do R & D?” the saving grace is that R & D expenditure is by definition highly speculative, and thus project expenditure will by and large be acceptable to the taxman as revenue expenditure. An exception would be the construction of facilities to house the R & D function, which would be capital expenditure.
The expenditure must be in one of the following categories:
1. Staffing costs.
2. Software, consumable items or consumable stores.
3. Sub-contracted R & D.
4. Externally provided workers.
Annual R & D expenditure qualifying for relief must be at least £10,000.
The expenditure must not have been met by another person or funded wholly or partly by government grant or subsidy.
What tax reliefs are available?
There are two tax relief regimes for R & D expenditure. I will deal with the small & medium-sized company regime and then highlight the differences in the large company system.
A small or medium-sized company is one that has less than 250 employees, and either a balance sheet total of not more than 43 million euros or turnover not exceeding 50 million euros. The company must be entitled to ownership of the intellectual property arising from the R & D expenditure at the time of creation, and cannot therefore claim relief on expenditure carried out as a subcontractor for another business.
There are 3 types of tax relief potentially available to SMEs:
1. A 50% enhancement to corporation tax relief on R & D expenditure (for example, £150,000 of relief would be available for £100,000 of qualifying expenditure).
2. Creation of a deemed trading loss before trading begins, on the above basis.
3. Payment of a tax credit of 24% of the enhanced expenditure where no corporation tax repayment is available (i.e. for loss-making companies).
Relief under 3 above is restricted to the company’s PAYE & national insurance liability for the relevant accounting period.
How does the large company regime differ?
The main differences in the large company regime are as follows:
1. The enhancement is to 125% of expenditure, not 150%.
2. The reliefs described at 2 & 3 above are not available.
3. There is no requirement for the company to own the intellectual property arising from the R & D.
4. The company can claim for R & D work subcontracted from another large company, but not an SME.
It follows that a SME can use the large company regime to claim relief for R & D expenditure on work subcontracted to them by a large company, which is not eligible for relief under the SME scheme.
Summary
The SME regime in particular gives generous and flexible relief for R & D expenditure. Any company engaged in groundbreaking work in science or technology needs to be aware of the reliefs, and to put in place procedures to identify and record R & D expenditure separately from other business costs. Completion and submission of a claim usually requires a combination of tax, accounting and technical expertise in order to get it right.
Mark Simpson
3 July 2007
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