Understanding R&D in the engineering industry

From automotive to aerospace, defence to civil engineering, the UK is a global leader in many forms of engineering and the research and development (R&D) that it encompasses. In fact, about 20% of the UK workforce is employed in engineering in one form or another, and it contributes a similar percentage to the UK economy.  

Defining R&D in the engineering context

Because engineering is about making things, improving processes and building the future, it is rife with R&D. Companies, especially SMEs, don’t always make this connection though; despite the fact that they may be extremely innovative.

R&D in engineering could include initial concept work, prototyping, the manufacturing process, testing and quality assurance and ongoing maintenance.

Here are a few examples to illustrate the topic:

• You are attempting to develop a new alloy for use in machinery which requires a high tolerance of harsh marine conditions.

• A filtration system is failing, and you need to understand why and how it can be improved which currently lies beyond the capabilities of the field.

• You are trying to improve the efficiency of components of hybrid electric vehicles.

• You are developing innovative building materials that enhance energy efficiency and sustainability in construction, such as researching and testing new composite materials for improved thermal insulation and reduced carbon footprint, ultimately advancing the field of sustainable construction technology.

• A production line is producing inconsistent results, and you are investigating the mechanical faults and exploring appreciable improvements to overcome them.

The role of R&D in engineering innovation

R&D in engineering innovation is often about solving technical problems or overcoming apparent limitations or compromises that make a product or project commercially unviable. For example, ensuring new buildings are aesthetically pleasing whilst meeting safety and environmental standards; or developing cheaper synthetic materials which do the same job as natural materials that have become too expensive.

R&D engineers also have to be responsive to continual changes in technology. Asking questions like “How can we integrate artificial intelligence into our product?” and “What added value can cloud technology bring?” and, when a new material is discovered – say graphene as an example from a few years ago – “How can this improve performance?”.

This kind of thinking is what puts many engineering firms at the cutting edge. It is what they need to consider to thrive and also opens the door to a valuable UK tax break which can be claimed: R&D tax credits.  

Qualifying for R&D tax credits in engineering

R&D tax credits are a UK government incentive to encourage innovation in the economy – the average benefit that we realise for our clients is £73K per year. They are potentially available to any limited company to claim, although engineering firms are particularly well placed to qualify for R&D tax credits based upon their core activities.  

You claim R&D tax relief through your corporation tax return, and it is based upon certain qualifying activity and expenditure. HMRC’s wording on activity is quite broad, and this is to ensure it doesn’t exclude a business from any particular sector. It does mean that you need expertise to match the HMRC definition of R&D to your activities.  

As we mentioned earlier, many companies do not realise the work they do can qualify, and when it comes to engineering firms there is strong potential for many. Let’s look at the wording.  

“R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology. The activities that directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D.”

Let’s draw out some of the nuance from this for engineering companies.  

• You need to be seeking to achieve and advance in science or technology. Much engineering work does deal with science and technology; so even if it seems mundane to you, if you are doing something new, it could be R&D.

• “Seeking” is a key word. You don’t need to be successful in your project. The fact that you are attempting to achieve an advance is enough for your engineering project to qualify.

• Resolution of scientific uncertainty. It is important that you do not know what the answer is before you start. There needs to be an element of risk in your project for it to be considered R&D.

You can see how this wording can be applied to any sector. We have already given a number of examples of how engineering projects could be R&D, but it could equally apply to a pharmaceutical scientist formulating a new medication without certain side effects or a software developer creating a custom integration.

For more real-life examples of R&D, read our client stories.

Calculating R&D tax credits for engineering

Calculating R&D tax credits for engineering works just the same as for any non-engineering R&D tax credits claim. Most companies will use a scheme called the Research and Development Expenditure Credit – RDEC for short – which offers a generous tax break. Some engineering companies may qualify for an enhanced tax break in a scheme called Enhanced R&D Intensive Support – ERIS – although there are stricter qualifying criteria for this.  

Qualifying expenditure

Regardless of which scheme you use to claim R&D tax relief, the same activities and expenditure are considered. We have already described how you identify qualifying activity, so let’s now look at the eligible costs you can include in a claim. These include:  

• Staffing costs – like salaries, pensions and employer NI for the element of people’s work associated with R&D. There may be some qualifying indirect activities too, such as specialist recruitment or cleaning.

• Consumables – These are things like the cost of power and water related to the R&D, plus any materials used up in the R&D process.

• Data licences and cloud computing – This is a new cost permitted for accounting periods commencing after 1 April 2023.

• Externally provided workers – If you and the staff provider are connected you can claim for 100% of any relevant payments, and if you are unconnected you can claim for 65%.

• Clinical trial volunteers – If you are in medical or pharmaceutical engineering for instance, the payments made to clinical trial volunteers are qualifying expenditure.

• Software costs – Where the software is solely for R&D you can claim for all the costs, and where it is more general but has some R&D use you can claim a reasonable proportion.

• Contracted out R&D – If you contract out R&D to a third party, you can claim these costs as the decision maker of the R&D.

RDEC for engineering firms

Where you have qualifying activity and expenditure under RDEC, you may claim an above the line tax credit of 20% of your qualifying expenditure. Above the line means that the tax credit itself is subject to tax. So the final benefit to you after tax has been deducted will be up to 16.2p per £1 of R&D expenditure depending on your tax position.  

For example, if you spent £200,000 on qualifying research and development, you would multiply this by 20% to arrive at a tax credit of £40,000.

If your corporation tax rate is 25% this would result in a post-tax credit of £30,000, representing 15% of your original £200,000 spend. If your corporation tax rate was 19% the benefit would be £32,400 making a 16.2% benefit.  

ERIS for engineering firms

To qualify for ERIS as an engineering firm you need to be an SME, be loss making, and spend at least 30% of your total business expenditure on R&D. This entitles you to a total benefit of up to 27% of your expenditure, but the way the tax relief is calculated is quite different from RDEC.

It is not an above the line relief, meaning that you do not pay tax on the credit. You calculate it by deducting an additional 86% of your qualifying R&D spend as you work out your adjusted trading loss, on top of the standard 100% deduction. This makes a total of 186%. Then, from the figure this yields, you can claim a tax-free payable tax credit worth up to 14.5% of your surrenderable loss. This produces a 27% benefit. Let’s see an example:  

You spend £200,000 on qualifying R&D expenditure, so when working out your adjusted trading loss deduct an extra 86% in addition to the 100% deduction: £200,000 multiplied by 1.86 makes £372,000. This is your adjusted trading loss and you can apply a tax credit of up to 14.5% which is £53,940 (and not subject to tax) which is 27% of your original expenditure.

Read more about ERIS.

Maximising R&D tax credits in engineering

To maximise your R&D tax credits in engineering you need to be able to marry a detailed understanding of the tax system with a thorough comprehension of your industry and identification of where innovation is truly taking place.  

HMRC expects any company claiming R&D tax credits to have a competent professional capable of understanding when new ground is being broken. But it is often beneficial for such companies to work alongside a specialist adviser like Kene Partners who can guide you on how to think about the tax incentive, follow best practices and ensure the latest tax rules are being complied with.  

Embracing R&D for engineering excellence and tax benefits

Having an R&D mindset can give your engineering firm much more than just tax benefits. While five or six-figure cash injections will help any business hugely (just like they are intended to do), by embracing R&D you are also setting yourself on a path towards creating better products and services, and attracting the best talent who are drawn to working on interesting projects.  

Why choose us?

At Kene Partners, we specialise in helping innovative businesses like engineering firms benefit from the tax breaks available to them. Our team blends heavyweight taxation and accounting experience with industry experts and PhDs who work together to advise you on what qualifies, how to record the evidence and your claim preparation. At a time when HMRC is clamping down on inaccurate claims, it has never made more sense to work with a trusted adviser like us, to maximise your opportunity whilst limiting your risk.  

Get in touch today

We would like the opportunity to help you so please arrange a free consultation today, or complete our free eligibility assessment.

‍