R&D tax relief for SMEs

If a company is a small to medium-sized enterprise (SME), tax relief may be claimed on a proportion of the expenditure on R&D activities.

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SME classification

A company is an SME if it has:

  • Total staff of fewer than 500 people and
  • A turnover of less than €100 million or balance sheet assets of less than €86 million

Connected companies may need to have their figures included for assessing SME thresholds. This is dependent on the connected company’s classification as either:

  • Autonomous: no external corporate entity owns 25% or more of its shares and if it does not own 25% or more in any other company
  • Linked enterprise: able to exercise control over the affairs of the other company usually through holding greater than 50% of company voting rights
  • Partner enterprise: not linked, but holds between 25% and 50% of voting rights

What costs qualify for R&D relief?

  • Staffing costs (including gross salaries, wages, overtime pay, and cash bonuses), employer national insurance contributions, and employer pension contributions
  • Payments to a subcontractor to carry out activities that are part of the company’s R&D. The subcontractor’s activities need not be R&D when considered in isolation, as long as the activities are part of a larger project that is R&D. Subcontracted analytical testing, for example, may qualify for relief. Only 65% of the total subcontractor costs can qualify for R&D relief, and relief may be available where the subcontractor is outside the UK
  • Costs of externally provided workers (EPWs), which are the staff costs paid to an external agency for staff who are directly and actively engaged in the R&D project. EPWs must carry out R&D activities under the supervision, direction, or control of the claiming company. Only 65% of the total EPW costs can qualify for R&D relief
  • Consumables, which are materials that are consumed or transformed in the R&D process. These include utilities such as water, fuel, and power
  • Software, including the cost of software licences utilised in the R&D activities
  • For accounting periods beginning on or after 1 April 2023, data licences and cloud computing utilised in the R&D activities

How are benefits calculated?

SME R&D relief allows companies to:

  • Deduct extra qualifying costs from their yearly profit
  • Claim a tax credit if the company makes a loss, which is worth a proportion of the loss that can be surrendered

From 1 April 2023 the rates of the enhanced deduction and tax credit are changing:

 

Enhanced Deduction

Credit (in lieu of surrenderable losses)

Before 1 April 2023

130%

14.5%

After 1 April 2023

86%

10%

After 1 April 2023 (R&D intensive loss-making companies)*

86%

14.5%

*There is an increased R&D tax credit of 14.5% for R&D intensive loss-making SMEs with qualifying R&D expenditure worth 40% or more of total expenditure for an accounting period. This will only be applicable once legislated.

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For companies making a profit

SME R&D relief allows companies to deduct extra qualifying costs from their profit for tax purposes.

Before 1 April 2023 an extra 130% of qualifying costs can be deducted and the net benefit (at a 19% corporation tax rate) is therefore 24.7% of the qualifying R&D expenditure.

After 1 April 2023 an extra 86% of qualifying costs can be deducted and the net benefit (at a 19% - 25% corporation tax rate) is therefore 16.3% - 21.5% of the qualifying R&D expenditure.

In some cases, the net benefit received may be lower where the enhanced deduction takes a company from a taxable profit to a taxable loss position.

Before 1 April 2023

After 1 April 2023 (profits greater than £250,000)

Trade profits

=

£1,000,000

£1,000,000

Corporate tax liability

=

=

£1,000,000 x 19%

£190,000

£1,000,000 x 25%

£250,000

Qualifying R&D expenditure

=

£100,000

£100,000

Enhanced deduction

=

=

£100,000 x 130%

£130,000

£100,000 x 86%

£86,000

Net tax benefit

=

=

£130,000 x 19%

£24,700

£86,000 x 25%

£21,500

From 1 April 2023 companies with profits lower than £250,000 can claim Marginal Relief which will result in a marginal rate of tax between 19% and 25%. This will affect the SME R&D relief net benefit.

For companies making a loss

SME R&D relief allows loss-making companies to claim a tax credit as a percentage of its loss that can be surrendered.

The surrenderable loss is equal to the lesser of:

  • The unrelieved trading losses
  • The qualifying expenditure plus the enhanced deduction

Before 1 April 2023

After 1 April 2023

Trade profit/(loss)

=

£(1,000,000)

£(1,000,000)

Corporate tax liability

=

£0

£0

Qualifying R&D expenditure

=

£100,000

£100,000

Enhanced deduction

=

=

£100,000 x 130%

£130,000

£100,000 x 86%

£86,000

 

The enhanced R&D deduction is subtracted from trading profits to give the unrelieved trading loss in the period. SME R&D relief allows companies to surrender losses in exchange for a cash credit.

Before 1 April 2023

After 1 April 2023

After 1 April 2023 (R&D intensive companies)*

Surrenderable loss is the lesser of:

·       Unrelieved trading loss in the period and

·       Qualifying expenditure plus enhanced deduction

=

=


=

£1,130,000

£100,000 x 230%

£230,000

£1,086,000

£100,000 x 186%

£186,000

£1,086,000

£100,000 x 186%

£186,000

R&D tax credit

Cash credit rate x Surrenderable loss

=

=

14.5% x 230,000

£33,350

10% x 186,000

£18,600

14.5% x £186,000

£26,970

* Only applicable once legislated.