R&D tax relief - the SME scheme

August 2015

Does the expenditure qualify for enhanced reliefs under the SME Scheme?

A company’s expenditure on in-house direct R&D may qualify for SME relief if it is revenue expenditure and incurred in relation to:

the cost of qualifying staff. Qualifying staff are those individuals directly and actively involved in the R&D, including researchers and managers, who plan, organise and carry out or support the R&D activity. The costs of members of staff must be apportioned if a relevant staff member is not involved full time with the R&D activity. The staff may not need to be directly employed by the SME, as the costs of externally provided staff under subcontracted arrangements involved in the R&D can also benefit from the tax relief;
software or consumable items used;
certain subcontractor costs; or
payments to clinical trials volunteers.

globe in hand There is no geographical restriction on the R&D activities qualifying for relief. This means that there is no requirement that any proportion of the activities take place in the UK; as long as the expenditure is deductible for tax purposes in the UK it should qualify for the relief.

Therefore, assuming all other necessary criteria are satisfied, expenditure by an overseas branch can constitute qualifying expenditure under the SME Scheme, as can expenditure by a UK SME on R&D carried out overseas. However, expenditure by an overseas subsidiary will not qualify for enhanced reliefs.

Subcontracted research and development

Where a company is claiming relief under the SME Scheme, it may be able to claim back 65% of what it spends on certain R&D activities carried out for it by a subcontractor. However, if the subcontractor is connected to the relevant company claiming the enhanced R&D reliefs, or an election has been made for connected parties treatment, special rules will apply.

In order for enhanced relief to be available in these circumstances, the subcontractor does not need to be an SME nor does it need to be UK resident. There is also no requirement for the subcontracted R&D to be performed in the UK. In addition, the work done by a subcontractor does not, on its own, need to qualify for R&D relief, provided it is part of a larger project of the claimant company which will qualify for R&D reliefs.

In assessing what will amount to "subcontracted activities", HMRC’s guidance indicates that where there is a contract between persons for R&D activities to be carried out by one for the other, then the R&D activities have been subcontracted.

By contrast, neither a contract to provide services (rather than to undertake a specific part of the activities) nor a contract of personal employment would be viewed as subcontracted R&D. Hence, for example, where a consultant simply provides expert advice and charges for his time, this would not amount to subcontracting of the R&D. Each case will need to be judged on its own facts, but as part of any examination, the degree of autonomy enjoyed by the person engaged, the ownership of the intellectual property and the economic risk in any arrangement should be reviewed.

Grants and subsidies

If all or part of the costs of a project are met by a grant or subsidy which is a notified State aid (notified to and approved by the European Commission), the expenditure on the project will not qualify for relief under the SME Scheme. However, SMEs which are unable to claim relief under the SME Scheme in these circumstances could still possibly claim relief under the Large Company Scheme.

If part of the costs of a project are met by a grant or subsidy which is not a notified State aid, then relief can only be claimed on that expenditure which is not met by the relevant grant or subsidy.

Cap on expenditure

An SME may only claim R&D relief to the extent the total R&D relief claimed for expenditure on a particular project does not exceed €7.5 million in total over the lifetime of the project. Where a large project could exceed this cap, it is worth considering whether the project could qualify as multiple separate projects, thereby minimising the risk of exceeding the €7.5 million cap. Any qualifying expenditure exceeding the €7.5 million cap could still qualify for relief under the Large Company Scheme.

What is the amount of the enhanced R&D SME relief?

The SME relief is taken as an additional deduction for tax purposes, reducing a profit or increasing a loss (to reduce future profits). If the SME is loss-making, the additional loss arising from the relief can be surrendered in exchange for an immediate repayment from HMRC.

The relief is given by allowing a company to deduct an additional percentage of its qualifying expenditure when calculating profits or losses for tax purposes (in addition to the 100% deduction which would be available under the general rules for deducting revenue expenditure). This can reduce the tax liability of companies with taxable profits or, for a loss-making company (where the relief is not surrendered for a repayment) it can increase the loss available to the company to carry forward or backward or which can be passed by the company to other group companies as a surrender of group relief.

The SME Scheme provides enhanced tax deductions at the following rates:

230% of the qualifying revenue expenditure in the relevant accounting period for expenditure incurred after 1 April 2015. That is, for each £100 of qualifying costs, the relevant company or organisation could have the income on which the corporation tax is paid reduced by an additional £130 on top of the £100 spent;
225% of the qualifying revenue expenditure in the relevant accounting period for expenditure incurred after 1 April 2012 and before 1 April 2015;
200% of the qualifying revenue expenditure in the relevant accounting period for expenditure incurred after 1 April 2011 and before 1 April 2012;
175% of the qualifying revenue expenditure in the relevant accounting period for expenditure incurred on or after 1 August 2008 and before 1 April 2011; and
150% of the qualifying revenue expenditure in the relevant accounting period for expenditure incurred on or after 1 April 2000 and before 1 August 2008.

R&D tax credit

If the SME incurs an allowable trading loss as a result of R&D relief, then the company has the option of surrendering to HMRC part or all of the loss relating to the R&D relief and claiming an R&D tax credit in the form of an immediate cash payment from HMRC.

The SME can surrender to HMRC a loss (the “surrenderable loss”) equal to no more than the lower of:

225% of the qualifying R&D expenditure (i.e. all of the expenditure plus the relief); and
the total loss of the trade, after deducting any claim made (or which could be made) to set the loss against other profits or gains of the company in the same accounting period and deducting any other relief claimed for the losses (including losses carried back to earlier accounting periods or surrendered to group companies as group relief).

For expenditure incurred on or after 1 April 2014, the amount of payable tax credit that a company is entitled to for an accounting period is 14.5% of the surrenderable loss for that period.

Can UK subcontractors claim R&D reliefs?

A company cannot claim R&D relief under the SME Scheme if it is a subcontractor (i.e. if it has been subcontracted to do the work on behalf of somebody else). However, in some cases the SME company which has been acting as a subcontractor, will still be able to make a claim under the Large Company Scheme.

If you have any questions on this article or would like to propose a subject to be addressed by Synapse please contact us.