Research and development credits are more than just handouts from the taxman

Turning a looming corporation tax bill of £11,500 into a refund of £8,500 sounds impossible – but electronics company AV has achieved just that through research and development credits.

The Government introduced the Research and Development (R&D) Tax Credit Scheme in 2000 to encourage companies to spend more on developing new technology and working methods. Initially targeted at smaller businesses, the scheme has since been extended to larger companies as well.

Seek professional help

Electronics firm AV had been told they did not qualify for the credits, but had patent applications pending for five elements of their inventions. With the help of accountants Harris & Company, who have claimed back around £460,000 for 15 companies in the last few years, the refund of £8,500 came within two months.

‘The scheme is looking for novelty and an element of innovation. You can generally tell if something is genuinely new – a round wheel painted pink is not good enough, but if you have invented a square wheel, even if you then binned it, that may qualify,’ advises Angela Peden, partner at Harris & Company.

There are a number of terms and conditions companies must meet, beyond the criteria outlined and these hurdles can put off smaller companies from pursuing claims. However, Peter Denison-Pender, associate director of technology consultant Interregnum, believes many companies could benefit.

‘The basic rule is that the Inland Revenue won’t give you back more money than the company, as a whole, has already paid in tax, via PAYE, National Insurance and other routes,’ says Denison-Pender, who has helped more than 30 clients to claim back money.

Wipe out your losses

Research must be ‘new and innovative’, offering a leap forward or ‘appreciable improvement’ to an existing process, product or service. The research must also be ‘subject to technological uncertainty’, so that it could fail.

The work must also be conducted in a ‘systematic and methodical fashion’. Denison-Pender says this means ‘Sir Alexander Fleming’s accidental finding of penicillin in his petri dish would not have qualified for the tax relief.’

He adds that these tests mean that ‘companies must have in place a paper trail to show exactly what resources were devoted to the research work.’ He points out that ‘it doesn’t matter if the research fails, or there is no commercial advantage gained, so long as everything in the process is documented.’

Companies that have a major shareholder also have to be careful, says Denison-Pender, as, if an outside organisation has more than 25 per cent of a company, the business will be considered a subsidiary of the larger concern and so not eligible for the more generous smaller company scheme.

Potential pitfalls
Denison-Pender also says there have been problems with the scheme. ‘The definitions of R&D which qualify have had to be refined as many IT companies were excluded.’

Andy Nash, a senior tax partner at accountant and adviser Baker Tilly, says that, from his personal experience, there can be a lot of paperwork involved, but the claim itself is quite straightforward.

‘However, the process can get complicated if your company is running a number of different R&D projects, as problems can arise if some qualify whilst others don’t. Clearly, the Inland Revenue will look at claims very closely,’ he comments.

Stuart Cochran, director of R&D at Tertio Telecoms, which retained Interregnum to handle its claim for R&D tax credits, said the work involved had unexpected benefits for the business. ‘The discipline imposed on us helped sharpen up our time-keeping and project management. This impact, together with the cash benefits, has given us even greater incentive to spend more effectively on R&D.’

Case Study – How the R&D tax credit scheme saved us £200,000

For the last two years, Link Research, which manufactures wireless links for the television and broadcast industry, has managed to save up to £200,000 by claiming back cash through the R&D scheme. Founder Les Mann says he has always used advisers to help him look for ways of performing better financially.

‘Our accounts manager was invited to an Inland Revenue road show and, as we didn’t really understand what the R&D scheme could mean for us, we thought it would be worth going to. It was very informative, and was our first big impetus to go for it,’ he recalls.

In Mann’s words, the application process was a no-brainer, but it was then the difficulties started.

‘Half of our employees are involved in R&D, so our claim was quite big. This prompted the Inland Revenue to make an enquiry – it felt similar to getting a summons in the post. I did freak out slightly. On the one hand, the Government is encouraging businesses to claim, but if you put in one like ours, you are treated with suspicion. We’ve had two such enquiries, which can be a shame. People have had to prepare additional reports, which is time-consuming.

‘I would recommend the scheme – but be very careful how you go about it. You need to have actual evidence to back up your claim. We mostly had records that complied with our claim, but we had to gather additional testimonials,’ he warns.

Need to know – What are the rules?

The rules are different for small and large companies, with size defined by the European Union.

Larger companies effectively gain a five per cent reduction in the amount of tax they have to pay on expenses relating to such research. But smaller businesses, with fewer than 250 employees and, either turnover below c50 million or balance sheet assets below c43 million, can claim back 24p in cash for every £1 of taxable expenditure.

To claim cash back, the company itself must be loss-making, otherwise the credits would merely reduce the overall tax bill. Overall a company must spend at least £10,000 on R&D activity in order to make a claim.

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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R&D tax credits