In years gone by, there was a common perception of R&D being something that only organisations like NASA would undertake; the reality, though, is that R&D is a staple practice of many UK businesses. In fact, it is one that helps drive the British economy through innovation.
The UK government rewards companies that perform qualifying R&D with tax relief – there currently are two types of R&D incentive (though this may change in 2024), and you have to know how to claim correctly. The challenge for many companies is that if you don’t know you are carrying out R&D, or don’t know about the tax relief, you will miss out on this valuable source of funding.
This article will look in depth at what R&D is, what R&D tax reliefs are available and the best practices you should follow to claim them.
What is Research & Development in business?
R&D stands for research and development, and its definition for tax purposes is predicated on overcoming uncertainty in order to make an overall advance in your particular field. This can include projects for clients, and projects that were not ultimately successful. But you have to demonstrate that your project’s aims and outcomes were not readily deducible at the outset.
R&D is therefore the activity you undertake when you are seeking to make an advance in your field using science or technology. Perhaps you are pushing the boundaries of knowledge and solutions in your sector, perhaps you are making improvements to what already exists, or seeking to create something new.
The legislation for R&D tax credits is purposefully broad, in order to capture innovation in businesses of all sizes and sectors. This innovation can take place when you:
- Develop your own products
- Build bespoke solutions for your customers
- Create proprietary tools or systems to facilitate your work
- Seek to improve the accepted industry standards
Like many businesses who are improving their awareness of the R&D tax incentives, you may recognise that you are conducting R&D in your normal day-to-day activity, but what does this mean in a tax context?
HMRC’s definition of R&D is surprisingly broad. There are, though, some notable exclusions.
At a high level, HMRC defines research and development for tax purposes as activity which is attempting to resolve scientific or technological uncertainty. This means that it does not matter how big or small your company is, or what sector you are in, there is potential for you to be conducting research and development in this sense.
One strong indicator that you may be carrying out R&D for tax purposes is if you are unsure of the outcome of your project or whether it is even possible. Unsuccessful R&D endeavours can still count as R&D for tax purposes and can be rewarded with tax relief.
R&D tax relief is provided through the corporation tax system, so you have to be a limited company for your R&D to count for tax purposes. Social sciences and market research are specifically excluded from the R&D tax credit system, so they can still be R&D, but not R&D for tax purposes.
What is R&D tax relief?
R&D tax relief is a government incentive that rewards innovative businesses taking financial risks in projects with uncertain aims, as described above. It is often referred to as R&D tax credits.
There are two main schemes through which companies can benefit (though this could all be set to change in 2024). The schemes are known as RDEC, which is predominantly for larger companies; and the SME scheme for small and medium sized companies.
R&D tax relief is claimed retrospectively and you can look back over two accounting periods to claim. It is calculated based upon the qualifying costs within qualifying projects. There are many types of qualifying costs, including expenditure such as staffing and utilities costs attributable to R&D projects. Your own R&D projects or subcontracted R&D projects can both qualify. You can read all about R&D tax relief here.
Depending on what scheme you use and whether you are profit- or loss-making you may receive the financial benefit as a reduction in your corporation tax bill or as a cash credit. Either way, it is a major funding source for eligible businesses.
For example, the average cash boost which we are able to generate for our clients per annual claim is £73K.
Why not take our eligibility test to see if R&D you are already doing could qualify you for R&D tax relief?
How does research and development help UK businesses?
The benefits of conducting research and development and receiving R&D tax relief can be substantial for your business.
New or improved products
Research and development projects will often be for the purpose of helping you create new or improved products. These will help you boost sales and/or maybe charge more for superior products which offer better value for customers.
A track record of research and development will enhance your reputation in the market. This could either be through more premium products or, perhaps, bespoke solutions which customers know they can come to you for when your competitors are unable to assist them.
Better systems and processes
Your R&D may not be focused on products themselves, but on your internal tools, processes or systems for operating. This could lead to efficiency gains which help you become more profitable and increase the capital value of your business.
Attracting talented staff
Because they take place at the cutting edge, R&D projects tend to offer staff interesting problem-solving work. This may help you with both recruitment and retention for attracting high-quality staff who are drawn to such work.
R&D tax relief and other funding opportunities
Where R&D qualifies for R&D tax credits, this tax relief can provide an important source of funding to your business. It will only cover a proportion of your R&D expenditure, but it is a welcome and valuable addition.
It is up to you what you do with money received from R&D tax credits, but by reinvesting it in further R&D – through hiring a specialist, or acquiring a new piece of equipment, for example – you can even achieve a kind of compound growth to your R&D programme, by each year building on and adding to what’s been done before.
What sectors adopt R&D?
It is thought that one of the reasons that HMRC’s definition of R&D is so broad is so that it does not, by default, exclude any sector. As long as you are a limited company, meet the definition described above relating to a scientific/technological advance and uncertainty, and have qualifying expenses then you may qualify for R&D tax relief.
To provide you with examples from what you may think of as non-traditional sectors for R&D, consider the following:
- An architectural practice which is asked to achieve a particular thermal performance standard in a building using new, sustainable materials which are not known to have met this standard before.
- A software business which needs to develop new security protocols around its APIs, and is not certain what will be required to achieve them.
- An engineering firm which needs to create an alloy which will adhere to very precise tolerances within a piece of machinery.
R&D strategy: Approaches to research and development
There is no set definition of what an R&D process or project looks like in a business. You might even be carrying out R&D unknowingly when you start exploring new possibilities.
An R&D cycle may look something like this:
- Feasibility studies: defining limitations in what already exists; identifying the uncertainty
- Research, problem-solving, trial-and-error.
- Design and development, including prototypes.
When you come to look at your R&D project for tax purposes, you will need clarity to be able to identify where the limitations in your current knowledge were and your uncertainty as to how you would make a scientific or technological advance to overcome the limitation.
In the course of a year, you can have one or more R&D projects which run concurrently or one after another.
How should we carry out R&D to qualify for R&D tax relief?
If you want to claim R&D tax relief, you will need to be prepared to demonstrate the qualifying activities and costs which are to be included in the claim.
Keeping R&D tax credit records
It would be best practice to keep clear records of expenditure as it is made, timesheets of staff involved, and the successes and failures of the project(s). You will also need to identify a technical expert in your business capable of defining the current limitations of knowledge and when advances were sought.
After you have been through the claim process once, all the above good practice becomes essential for the credibility of your future claims. On subsequent R&D tax credit claims, drawing on good quality records becomes even more important.
Why use a specialist R&D adviser to claim R&D tax relief?
Specialist R&D advisers play a key role in both optimising the value of a claim, and ensuring it is robustly prepared in line with best practice and the legislation. HMRC enquiries are becoming increasingly common, so you’ll need to make sure your claim is well-evidenced and accurate upon submission. Failure to support and substantiate your claims and associated costs can result in penalties from HMRC, and you should always check that your adviser will support you through an enquiry.
At Kene Partners, we know how to apply R&D tax relief rules to projects to ensure that all qualifying activity is included in a claim.
We also stay ahead of a changing R&D tax landscape. This year alone, new requirements for Advance Notification of claims and an Additional Information Form have been introduced. We ensure that all claims are prepared correctly in line with the latest legislation updates.