Technological innovations are one of the main drivers for change in our society. Think of all the changes that you have witnessed in recent years which are in large part due to technological development; Oystercards, contactless payments, taxi apps… the list is endless. However, such innovations rely not only on technology, but also blood, sweat, tears ….and money.
As has always been the case, there is never enough money to go around. But the good news is that a tax break offered by the Taxman does allow your limited funds to go further. Much further.
This particular tax break is called R&D Tax Relief.
If your startup is liable for Corporation Tax, it may reduce the company’s tax bill. Alternatively, if your company is a SME (“small or medium-sized entity”), you may choose to receive a tax credit (a cash lump sum) instead, from HMRC.
What qualifies as R&D?
HMRC says a company can only claim R&D Relief if a project seeks to “achieve an advance in overall knowledge or capability in a field of science or technology through the resolution of scientific or technological uncertainty” .
Whilst this is a lot of words, the two words you need to concentrate on are “technical uncertainty”.
If, at the start of your project, you are (or were) uncertain whether your planned approach would work, you have technical uncertainty. Similarly, if you had to spend time understanding and diagnosing an issue, testing for a solution and then developing a prototype to test your proposed solution, there was technical uncertainty.
Even if a competitor has already developed a similar product or solution, provided this is not available on the open market and you had to effectively undertake the development process from scratch, that project would also qualify for R&D.
The more techie bits of making a R&D Tax Relief claim
There are two schemes for claiming tax relief, depending on the size of the company. There’s the SME scheme (which will apply to tech startups in most cases and what I’ll focus on here,) and the Large Company scheme. The good news is that the SME scheme is more generous than the large company scheme, having higher rates of relief.
The value of the tax credit depends on the amount of “qualifying R&D expenditure”. The rules for identifying qualifying R&D activity and calculating R&D expenditure are complicated and will almost certainly be different to what an entrepreneur would classify as R&D.
Any R&D that you’re claiming for must:
- be related to your trade – either an existing one or one that you intend to start up based on the results of the R&D; and
- own any intellectual property that might arise from the project.
The SME Scheme
Since 1 April 2015, the tax relief on allowable R&D costs is 230% – that is, for each £100 of qualifying costs, your startup could increase its expenses for tax purposes (and reduce its taxable profits) by an additional £130 on top of the £100 spent.
Therefore, for tax purposes, the Taxman treats every £100 of R&D expenditure as though it had cost your company £230. That’s some increase!
Alternatively, in some circumstances, it is payable as a cash credit. The rate of R&D payable tax credit for loss making SMEs is 14.5% of the calculated “qualifying expenditure”.
6 tips to maximising a successful claim
- Bring forward a tax credit claim
You can only claim a R&D tax credit as part of the Corporation Tax return (or CT600, as it’s otherwise known). Therefore, potentially, you’ll have to wait twelve months – or more – before the accounting period has finished and you’re able to make a claim. However, there is a way around this frustrating problem. A company is able to shorten its accounting period if it chooses. There’s nothing to stop a company from shortening its accounting period to the month in which its R&D project finishes in order to bring forward the tax claim. Just be aware that you can only change your accounting period once every five years, so choose wisely.
- Incorporate the business early
I meet many entrepreneurs that simply weren’t aware that R&D tax credits may only be claimed by businesses that are liable for corporation tax. As a result, for the period that they operated as a sole trader or under a loose partnership arrangement, they may be unable to claim R&D tax credits. The lesson here is to incorporate your business early.
- Don’t forget to pay yourself for R&D work
In most cases, a major part of any R&D tax credit claim will be the salaries paid to people employed in R&D work. Quite often R&D personnel include the founders. If the founders do not take a salary from the business – in order to help preserve cash in the short term – they may be missing out on tax credits. Remember, tax credits can only be claimed where there has been a cost to the company. It’s also good to know that if you’re a founder and you want to preserve cash, you can always loan the money back to the company.
- Timesheets are crucial
The chances are that the people you have hired to undertake R&D work, including employees and subcontractors, are doing a mixture of qualifying R&D work and other activities. As you can expect, its very difficult for anyone to remember exactly what proportion of their time was taken up with R&D related activities. This can lead to disputes with HMRC over what proportion of a person’s salary or subcontractor fee may be claimed for R&D Tax relief. A simple way to avoid this issue is to ask employees to complete a timesheet. This doesn’t need to be minute-by-minute, but should be completed at least weekly to help identify R&D expenditure.
- Make sure that you can claim under the SME scheme
Whilst in most cases, a startup will be able to use the SME scheme, there are certain situations where even SMEs may have to claim under the less generous Large Company scheme. This means that, if your company is a SME, you may be able to claim R&D Relief under the SME Scheme for one project and the Large Company Scheme for another.
- Claim whilst the startup is a going concern
If you’re a SME, then you can only claim R&D relief if your company is a going concern when it makes the claim and isn’t in administration or liquidation at that time. If your startup ceases to be a going concern after making a claim but before any credit is paid, HMRC treats the claim as if it has not been made and you can’t get tax credit.
Next steps – what you should do next
If you would like to know more about R&D Tax Credits, a good starting point is the information supplied by good old HMRC www.gov.uk/corporation-tax-research-and-development-rd-relief , but it can be a little generic (and even misleading!) in places. If you would like advice to help your particular circumstances, I’d recommend arranging a consultation (ideally a free one) with a qualified tax advisor that’s familiar with tech startups and the tax breaks available to them.
Best of luck with your new venture and R&D projects.