How to better forecast your R&D tax claim

Diagnostax Blog 2: R&D Better Forecasting

How to better forecast your R&D tax claim

When R&D tax relief first fell onto your radar, you were no doubt blown away by the generous benefit, of up to £33 back for every £100 you invest in R&D. But the truth is – as you may have already experienced – for R&D projects, the amount you can claim ranges anywhere from 0 to 33%, depending on several factors.

As a business that is investing in research and development activity, and making R&D tax relief claims, it’s important for you to have as much certainty over your R&D claim, as early as possible, even as early as the planning phase. But why?

Well, an R&D claim only gets you money back for costs you have already incurred. This means you’re not going to get any benefit from the investment until at least a year or so down the line, or if you’ve really got your act together, several months.

Getting a better understanding of what will qualify before the project, allows for a more accurate estimate of the true cost of the investment, at the outset. At the front of the project this enables more accurate budgeting for the time and resource invested. At the back of the project when the claim comes to realisation, this enables more accurate cashflow forecasting so you can plan for any potential future investment.


SO, WHAT IS THE TRUE COST OF MY R&D??

To get a better understanding of the true cost of your R&D investment, there are three big questions you need to be able to answer BEFORE you kickstartyour next R&D project:

  1. Is it even an R&D project?
  2. What qualifying activity can I claim for?
  3. What R&D rate should be applied to the qualifying activity?

Let’s take a look at each of these questions in a little more detail….

R&D investment
  1. Is it even an R&D project?

You’ve got to get past this hurdle first and believe us when we say, we still work with businesses that misidentify R&D projects all the time. To err on the side of caution it’s best to keep a record of all projects that you think will qualify and check it out with your R&D adviser if you are unsure.

So, how do you know if your project is eligible?

Well, to be eligible, an R&D Project must be:

Making a considerable improvement to existing technology. This doesn’t always mean it needs to be ground-breaking work. If you are working to overcome technical uncertainties in order make your products, services or processes, faster, less expensive, or better in some way, the project may be eligible for R&D tax relief.

AND


Overcoming technological challenges, where the solution is not readily apparent to a qualified or experienced professional in their field of technology.

If it’s an R&D project, then it goes on the list, and you need to determine what costs you’ll be able to claim.

R&D project

2. What qualifying activity can I claim costs for?

To qualify, R&D activity must fall into one of the below categories:

  • Staff costs
    You can include the salaries, pensions and NIC of staff who are directly involved in the R&D project.
  • Reimbursed expenses paid to employees or directors on R&D travel
    You can include reimbursed expenses claimed by employees or directors on travel related to the R&D project.
  • Outsourced subcontractors or freelancers
    You can include 65% of the costs paid for “unconnected” subcontractors (under the SME R&D scheme).
  • Materials for prototype builds
    You can include the cost of the materials required for designing and constructing a prototype which will not be sold.
  • Ancillaries – utilities, software licences
    You can include an appropriate proportion of utilities and software costs used in your R&D projects.

Unfortunately it’s not always black and white, and knowing whether the activity ACTUALLY fits into a qualifying category can throw up some tricky red herrings.

software costs used in your R&D projects

Here’s a couple to keep an eye out for:

Software and Hosting….

Now this one’s a little cheeky. Although software licences can be claimed, hosting costs on their own do not fit into a qualifying category of R&D. This can be frustrating as businesses often incur large hosting costs used purely for R&D, so feel they should be included…but currently they aren’t.

Having said that, hosting can often include a lot of services, and depending on how the company uses them, there is the possibility they could be eligible under the software licence header. As you can see, this area is complex and your R&D provider would need to look into this for you, to help apportion the amount linked to a qualifying category.

Storage, telecom and data costs are just out of the game, they do not qualify.

Staff time…

Time allocation for employees involved in R&D projects will often be one of your biggest costs, and so it is vital to apportion everyone’s time as accurately as possible to get better certainty over your R&D claim. Record time spent by those directors, employees, qualified staff working on the R&D project.

It’s also important to make sure you are including staff costs for all indirect qualifying activity. This includes roles of support staff where they are engaged in activities such as finance and HR, that indirectly support an R&D project

3. What R&D rate should be applied to the qualifying activity?

So now we know the project is eligible, and the different qualifying categories the activity must slot into (including the nuances), we want to know the R&D rate that can be applied to the activities.

There are three main factors that could impact the amount of the costs incurred that you can actually claim back:

R&D SME Scheme vs. RDEC Scheme

Depending on which scheme you are claiming under, this can significantly impact the rate you can claim.

  • RDEC SCHEME: Following the 2021 Budget, RDEC increased to a 13% tax credit for expenditure incurred on or after 1 April 2020. As RDEC is subject to corporation tax, the net of cash benefit is currently 10.53%
  • SME SCHEME: The SME R&D Scheme is currently an additional 130% tax deduction for qualifying expenditure. So this equates to a 24.7% cash benefit for profitable companies, and up to 33.35% cash benefit for loss making companies that can claim the SME “tax credit”. Also note that following the 2021 Budget, SME tax credit claims are now subject to an annual cap of £20k plus 300% of the company’s PAYE and National Insurance Contributions liability.

The other major difference with the RDEC scheme is that you cannot claim for costs paid to limited company subcontractors.

Subcontracting vs. Inhouse

If your business sub-contracts R&D work to a third party subcontractor (unconnected to your company) – you will still be able to claim for some qualifying costs but the relief may only be 65% of those costs.

NOTE. If you have taken on subcontracted R&D work to your business, you might not be able to claim R&D tax relief at all, or the only route available to you is under the RDEC scheme – reducing your claim to 10.53% of the qualifying expenditure.

Profit Position vs. Loss Position

The upfront cashflow benefit is actually greater for loss-making SMEs. Here’s a look at the how this affects the rates:

Loss: If you’re going to be in a loss position, then HMRC will make a cash payment to you of up to 33.35p for every £1 spent on R&D activities.

Profit: If you’re going to be in a profit position then HMRC will make a cash payment to you (or offset against your corporation bill) of up to 24.7p for every £1 spent on R&D activities.

Then timings come into play….

Loss: If your company is going to make a loss, you can make the claim as soon as your accounts are prepared and ready for filing.

Profit: If your company is likely to be profitable, it’s a little different. The biggest benefit will come by reducing the tax bill which is due nine months after your year end.

Diagnostax. If your company is likely to be profitable, it’s a little different. The biggest benefit will come by reducing the tax bill which is due nine months after your year end.

R&D for Financial Forecasting

As you can see there’s actually a lot to consider when it comes to forecasting your R&D claim. Any steps taken towards getting a more accurate idea of your R&D claim in advance of the project are worthwhile.

If you are a business that is already claiming R&D tax relief, you should be able to retrospectively use the information from your previous claims to help you navigate some of the more challenging nuances of R&D tax relief.

THINK YOU MIGHT BE ELIGIBLE TO CLAIM?

If you think you might be eligible to claim R&D Tax Relief, or you’d like to discuss your R&D claim with us, please book a call.

Outsourcing Costs vs. In House

Diagnostax Blog 3: R&D Outsourcing Costs vs. In House

Should I outsource my R&D activity or keep it in-house?

If you’re considering whether to bring some or all of your R&D project work inhouse versus outsourcing it, you’ll want to feel confident that you are making the right decision for your business operationally, but also to maximise your R&D claim.

Perhaps you’re about to kickstart a new R&D project, or you’re thinking about outsourcing as you don’t want to take on a new employee. Either way, we want to equip you with all the info you need to determine the best way to incur your R&D development costs: in-house or outsourced.

In the world of R&D you’ll often see outsourcing referred to as ‘subcontracting’. Let’s start with some definitions and explanations of what we mean when we say ‘subcontracting’.

SUBCONTRACTED WORK IN R&D PROJECTS

When it comes to R&D, subcontracted work is defined as when you contract and pay someone else to carry out R&D project activity on your behalf.

There are two scenarios to be aware of when it comes to subcontracted work in R&D projects:

SCENARIO 1: A business subcontracts work to you

If a business subcontracts R&D work to your business, you might not be able to claim R&D tax relief, or only a limited claim is available to you under the RDEC scheme – reducing your claim to 10.53% of the qualifying expenditure.

SCENARIO 2: Your business subcontracts work to a third party If your business subcontracts R&D work to a third party (unconnected to your company) – you can still claim for qualifying costs but the relief available is only 65% of those costs.

ONLY 65% OF COSTS CAN BE CLAIMED

ONLY 65% OF COSTS CAN BE CLAIMED

As you can see, before you make any decisions, there are some key points to consider, to determine the best way to incur your R&D development costs: in-house or outsourced.

As outlined above, if you are a business undertaking an R&D project for your own business, and you have sub-contracted part of the R&D project to a third party, you can only claim for 65% of the costs – and the R&D work must be for a specific part of the project.


Here’s an example of what this might look like for a business:

A UK company has an R&D project and they are considering whether to subcontract the design stage of the project, or use an in-house employee. The design stage is expected to take 6 months.

The annual salary of an adequately skilled employee is estimated at £60K.

CostEmployeeOutsourced
6-month salary£30,000 
Estimated additional fringe costs (pension, NIC, etc)£5,000 
Payment for project work to outsourcer £35,000
Initial cash cost to company£35,000£35,000
R&D allocation*90%100%
Subcontractor restrictionNil65%
R&D expenditure claimable£31,500£22,750

*You’ll notice the allocation of R&D time is slightly higher for the outsourcer, as employees are likely to have other responsibilities.

Let’s take a look athow the potential benefit breaks down for the Company:

A) For a Profitable Company

Corporation tax saving due to R&D£7,780.50£5,619.25
Difference£2,161.25 

B) For a Loss-Making Company

Tax credit claim£10,505.25£7,587.125
Difference£2,918.125

If the business is the subcontractor, they may not be able to claim under the SME R&D Scheme, but if they qualified under the RDEC scheme at 10.53% of qualifying expenditure:

Cash refund£3,316.950
Difference£3,316.95 

So when it comes to the numbers, it’s clear to see that the tax saving is more attractive if you go down the in-house route.

However, taking on a new employee is a big call to make, as it comes with its own challenges. There’s the cost and time involved in finding the right person, with the right skillset that will fit into the business. Then there is the ongoing time of managing that person. It’s a significant commitment to make

NOT CONVINCED IN-HOUSE IS THE RIGHT WAY?

If you’re on the fence when it comes to keeping your R&D in-house, here are some important pros and cons to consider if you’re considering the possibility of outsourcing your R&D……

keeping your R&D in-house pros

PROS

  • NO IN-HOUSE EXPERTISE: Sometimes you just don’t have a choice! For example you may be looking to develop a new app but with no expertise, subcontracting to a company with the expertise is the only option.
  • ACCESS TO MORE TALENT: By subcontracting, you have access to a greater pool of talent, global even!
  • CHEAPER & FASTER: When it comes to R&D projects that are completely different to anything that you have done in the past, it can be much cheaper and faster to look at subcontracting rather than setting everything up in-house from scratch.
  • SYSTEMS & PROCESSES: A quality subcontractor will already have the robust systems and processes in place to ensure the R&D work is tracked and expectations are managed – potentially a huge weight lifted.
  • STAY FOCUSED: Outsourcing to a subcontractor helps to keep your business and its resources focused on what it is already doing.
keeping your R&D in-house cons

CONS

  • THEY DON’T KNOW YOUR BUSINESS: It can be difficult for sub-contractors to have the same level of understanding of your business as your employees. However, this doesn’t always have to be a negative, sometimes a different perspective is what is needed for innovation.
  • CONFLICT IN EXPECTATONS: It’s important expectations are managed, as differences of opinion can arise when it comes to the brief, the objectives or the quality of the work. This is particularly tricky if the requirements of the R&D work change after the project has started.
  • CONTROL & TIMING: Letting go of control, and the day-to-day running of the project work can be difficult. But the best way to address this is to discuss your requirements and agree milestones or check points to ensure the timely delivery of the project. The subcontractor should have processes in place ready to tackle this.
  • IP & CONFIDENTIALITY: Management of intellectual property, and the potential leaking of information is a risk when you take your R&D activity outside of your business. It’s easier to manage, and less likely to happen when all of your R&D activity stays in-house.
CONS •	THEY DON’T KNOW YOUR BUSINESS: It can be difficult for sub-contractors to have the same level of understanding of your business as your employees. However, this doesn’t always have to be a negative, sometimes a different perspective is what is needed for innovation.   •	CONFLICT IN EXPECTATONS: It’s important expectations are managed, as differences of opinion can arise when it comes to the brief, the objectives or the quality of the work. This is particularly tricky if the requirements of the R&D work change after the project has started.   •	CONTROL & TIMING: Letting go of control, and the day-to-day running of the project work can be difficult. But the best way to address this is to discuss your requirements and agree milestones or check points to ensure the timely delivery of the project. The subcontractor should have processes in place ready to tackle this.   •	IP & CONFIDENTIALITY: Management of intellectual property, and the potential leaking of information is a risk when you take your R&D activity outside of your business. It’s easier to manage, and less likely to happen when all of your R&D activity stays in-house.

THE VERDICT?

So, there you have it. Unfortunately, there isn’t a black and white answer. We’re sorry! Whether you outsource aspects of your R&D project has to be right for your business. Our advice? First, start with the calculations. Can you afford to lose 35% of your R&D claim money coming back into your business? Then, it is a case of being honest and looking at the business case of bringing in a new employee – how do the pros and cons stack up?

THINK YOU MIGHT BE ELIGIBLE TO CLAIM?


If you think you might be eligible to claim R&D Tax Relief, and you’d like to find out more about how we can help you make your claim, please book a call.

Diagnostax. Maximise your R&D claim

Diagnostax Blog 4: Maximise your R&D Claim

14 Quick wins to get EVEN MORE money back in your next R&D claim

Remember that feeling when your first R&D tax refund hit money hit your bank account? Well, we want you to feel this every time you make a claim! How? By making sure you are prepared and  maximising every R&D claim.

To help we have complied 14 quick wins to optimise your R&D claim. From missed expenses, to record-keeping, to choosing the right R&D scheme; even the way you are paid!

We’re confident there will be something new to consider, starting with expenses….

optimise your R&D claim

7 MOST COMMON OVERLOOKED EXPENSES

Here’s seven examples of costs that are commonly missed in R&D claims:

  1. Expenses paid on a personal card
    We see this time and time again. Here’s an example: A business spends £15k on travel to meet R&D sub-contractors; paid for on a company card. If the travel had been paid on a personal card and reimbursed by the company, they could have claimed back £5k!
  2. Expenses when acting as a subcontractor
    Easily overlooked and often misunderstood. Subcontractors working as a third party in R&D for a large company can claim expenses under the RDEC Scheme.
  3. Expenses delivering work for a customer
    Similar concept to number 2. If you are delivering a lot of R&D work for third parties; don’t assume the work doesn’t qualify because it is for another company – keep a record of all R&D projects the business is involved in internally and for third parties.
  4. Rent bundled into a package
    You might not be aware that rent cannot be included in your R&D claim…unless it is bundled into a package with say your utilities. If your circumstances change, make us aware, as this could make part of your rent claimable.
  5. Expenses for non-technical support staff
    The best advice for staff costs is to keep a record of all staff involved in R&D projects (technical or not). They might not all qualify but if there are supporting roles involved you may be able to claim money back for your business.
  6. The Planning Stage
    Many businesses fail to include the planning stages for R&D projects, thinking it only begins when the materials costs kick in for example. But an R&D project doesn’t just start. There is always an element of time invested into preparatory work. Include it.
  7. Pre-trading expenses in a first R&D tax credit claim
    For newly formed companies, you can include qualifying pre-trading expenses in an R&D claim. This isn’t relevant for existing claims but for customers who have setup new companies that could qualify for R&D. Substantial research and development can often take place prior to a company beginning to trade and can be included in your R&D claim. In fact an R&D cash credit can even be claimed before a business starts to trade.

IMPORTANCE OF QUALITY RECORD-KEEPING

It’s vital to get a grip of good record-keeping for R&D projects, as it can really improve your R&D Tax Relief claim, leading to more money back and a robust audit trail.

  1. Review existing systems for record-keeping
    A quick win for record-keeping is to follow these three steps to see what you are doing at the moment and where there could be improvements or modifications:
    STEP 1 – Identify the records you can be confident in
    STEP 2 – Then determine where you are estimating
    STEP 3 – Tweak your systems to give greater confidence
  2. Keep a list of R&D Projects
    Keep a list of all the R&D projects that you’re working on, to make sure no projects are missed. Even if they turn out not to be eligible – there could be entire projects you are missing out altogether.
    TIP: An additional good practice tip to include here, is to keep a record of the advances sought and the uncertainties present before you kick-off an R&D project.
  3. Tracking Consumable Materials
    Issuing an in-house purchase order is a great way to track costs of any consumable materials you use for your R&D projects.
  4. Tracking Staff Costs
    Staff costs are one of the key expenses to claim, and so it’s critical to evidence the time of those involved in R&D Projects, if you are looking to maximise your claim to the fullest. We recommend incorporating real-time systems for timekeeping, such as Clockify.
  5. Subcontractor contracts
    Now these are important and worth exploring for future R&D claims. Your R&D claims could be improved by agreeing in subcontracting relationships, who can claim the R&D. Only one party in the relationship will be eligible for the tax relief, as you can’t both claim for the same project. We recommend putting a contract in place which details who has rights to the claim.
Diagnostax. To claim R&D you need to be a limited company

YOUR COMPANY STRUCTURE

To claim R&D you need to be a limited company, within the scope of corporation tax (but note you don’t actually have to be paying it i.e. loss making companies can claim). There are then a few things you should consider towards ensuring your claim is maximised.

  1. Revisit your Salary & Dividends
    Salaries can be included in your R&D claim, BUT dividends cannot. If you are a Director – heavily involved in R&D projects – taking a small salary and much higher dividends, it’s critical to revisit how you are paid to maximise your position personally and for the R&D claim.
  2. Part of a larger group?
    Companies face several pitfalls if they do not plan correctly.
    For businesses that are global, you can only claim for UK-based company R&D expenditure. Bearing this in mind, you need to think about where the R&D takes place within the group – who leads the R&D? Who employs the staff involved in R&D? There are some exceptions where you can recharge costs, but not all roles will qualify.
    If you are a small company operating within a large group, you should consider the benefits of accessing the higher rate of relief from the SME R&D Tax Relief Scheme.

LOOKING TO MAXIMISE YOUR NEXT CLAIM?


If you’re looking ahead to your next R&D claim, book in a scoping call and let’s make sure you are ready to take your claim to the max.

Diagnostax. R&D software expenses

Diagnostax Blog 5: R&D and Software Expenses

R&D What software expenses can I claim for?

Almost every R&D Tax Relief claim that we process includes some form of software costs. But it’s hardly surprising, as every business today has software costs. We use software in just about every business process we do! It’s also the one R&D cost that most businesses feel comfortable with, when they come to make their R&D claim.

But what you might not know, is that there is one big grey area, meaning certain software costs cannot be claimed.

Let’s find out the fundamental rules when it comes to software costs, and what exactly this mysterious grey area is.

R&D software expenses

SOFTWARE COSTS: THE FUNDAMENTAL RULES

The rules around software costs would appear to be straightforward:

  • If the software has been purchased only to be used in an R&D project, then you can include 100% of the cost in the R&D tax claim.
  • If you use the software for other business activities that sit outside of the R&D project, then you need to calculate an appropriate proportion of the software’s cost to be included in your claim.

Simples, right?

Diagnostax. R&D software costs

SOFTWARE COSTS: THE GREY AREA  

With software, there are often ‘other costs’, that are incurred alongside the software when it is leased from external parties. It’s these costs where the grey areas start to creep in. These costs fall under the banner of ‘cloud computing’ and charges could be for a whole range of activities, including use of software, storage rental, and support.

Diagnostax. CLOUD COMPUTING & HOSTING

CLOUD COMPUTING & HOSTING

Cloud computing and hosting is particularly relevant for businesses that are involved in R&D projects related to the development of software. It’s these ‘cloud computing’ costs that unfortunately do not meet the requirements of any of the qualifying criteria to make an R&D claim. It’s quite common for businesses to purchase packages which are used to support activity across their business operations as well as R&D activity. Therefore, it’s key to track the costs dedicated specifically to hosting the testing and development environment, when using the services.  The likelihood is you’ll be using software somewhere in your business, and it could impact your R&D claim. Like a lot of R&D categories, software has its grey areas, but that’s what we are here for, we will work with you to ensure you submit an accurate R&D claim.

As we speak new changes are on the horizon to include cloud computing and data costs, but stick with us and we’ll make sure you’re up-to-date as the changes come in.

THINK YOU MIGHT BE ELIGIBLE TO CLAIM?


If you think you might be eligible for R&D Tax Relief, and you’d like to find out more about how we can help you make your R&D claim , please book a call

Subcontractor or Contractor - what R&D can I claim

Diagnostax Blog 6: R&D Subcontractor or Contractor

Subcontractor or Contractor – what R&D can I claim?

Subcontractors. Maybe you use them, maybe you are one, maybe you are acting as one for a one off project. Whatever the circumstances, when it comes to R&D Tax Relief, subcontractors should be considered carefully when claiming R&D Tax Relief. On too many occasions now, we have seen companies miss out on money that should have been back in their business, and we don’t want that to be you.

In this article, we look at eight rules to determine WHEN subcontractors, and contractors can claim, and WHICH scheme you can claim via.

KEY TERMS & DEFINITIONS

Let’s start with some key terms and definitions, as it might get a little technical in here….

The Contractor is the company that has ownership of the R&D project, and hires the Subcontractor.

The Subcontractor is the person or company hired to deliver work that contributes to the R&D project.


There are two different Subcontractor types:

A Connected Subcontractor is a company or individual controlled (meaning owned more than 50%) by the same shareholder(s) as the contractor.

An Unconnected Subcontractor is any subcontractor that is not a connected subcontractor.


Finally, here is a very quick description of the two R&D schemes available to claim via:

The RDEC scheme allows a company to claim up to 13% cash back of qualifying costs incurred.

The SME scheme allows a company to claim up to 33% of cash back of qualifying costs incurred.

Diagnostax. R&D Subcontractor claim

SUBCONTRACTORS: WHEN CAN I CLAIM & WHICH SCHEME SHOULD I USE?

As a subcontractor there are two main scenarios with specific rules around when and what R&D you can claim for.   

SCENARIO 1 – When acting as a subcontractor to a large company, the subcontractor can claim but only via the “RDEC” scheme.

Example. A small company who specialises in testing products to satisfy a certain legal regulation. If a large multinational company was making a new product and contracted the small company to do some tests, the small company can potentially claim under RDEC.

Note that in this case the large company cannot claim for the costs paid to the small company, so there is no risk of a ‘double claim’ occurring.

SCENARIO 2 – When acting as a subcontractor to anyone, but you are doing your own separate R&D project alongside that work, you can claim via the SME scheme.Example. The small company above is improving an internal process for the testing of products that will lead to efficiencies in the delivery of its services to all customers. Staff within the team spend time specifically trying to develop the process. This could count as a separate project, claimable under the SME scheme.

SUBCONTACTORS CAN’T CLAIM WHEN…… acting as an SME subcontractor to another SME for their R&D project.

Example. The testing company above is doing work as a subcontractor to another SME. The SME contractor may be able to claim (under the SME scheme) for the payments to the testing company, and so to avoid a ‘double claim’, the testing company cannot make a claim itself for work on this project.

Diagnostax. R&D contractor claim

CONTRACTORS: WHEN CAN I CLAIM & WHICH SCHEME SHOULD I USE?

As a contractor there are four main scenarios with specific rules around when and what R&D you can claim, for payments to subcontractors:

SCENARIO 1: When a large company subcontracts to individuals, partnerships or qualifying bodies (excluding limited companies), it can claim via the RDEC scheme.

Example. A large multinational contracts some research from a university on its project.

SCENARIO 2: When an SME company is grant funded / subsidised and subcontracts to individuals, partnerships, qualifying bodies (excluding limited companies), it can claim via the RDEC scheme.

Example. A small company wins a grant to develop proprietary software for an online portal that will have significant economic and environmental impact if adopted by the target market. Some of the software development is contracted to a freelancer who is an individual. These subcontracted costs could be claimable under the RDEC scheme.

SCENARIO 3: When an SME company subcontracts a specific part of an R&D project to an unconnected party, it can claim for 65% of the costs as qualifying expenditure via the SME scheme.

Example. The same company as above is developing a similar piece of software to test commercial application in a different industry. A third party company is used for the some of the development work costing £30,000. A claim may be available for this cost, under the SME scheme, for up to £6.5k as a cash credit.


SCENARIO 4:
 When subcontracting R&D work to a connected subcontractor, you can usually claim via the SME or RDEC scheme, however the rules for what you can claim for may be more or less restricted based on the circumstances.


CONTACTORS CAN’T CLAIM WHEN
…… subcontracting to Limited companies under the RDEC Scheme.

Example. The company above, who won a grant to develop proprietary software, outsourced some of the software development to individual freelancers, and some to a limited company agency. Only the costs paid to the individuals is within scope to claim. The amounts paid to the limited company cannot be claimed.

HMRC PAYE CAP

HMRC PAYE CAP

Please note from 1 April 2021, HMRC brought in a limit on the payable tax credit a business can receive from a claim via the SME R&D Tax Credit Scheme. Businesses can now only claim R&D Tax Relief up to the value of 300% of their combined PAYE and NIC liability. The first £20,000 is exempt, but any amount above this threshold will be capped.

The cap specifically applies to businesses that are unprofitable, and businesses that end up with an ‘artificial loss’, which they could then surrender for a cash injection, because of the enhancement mechanism of the R&D Scheme. In these circumstances, subcontractor fees from businesses that are unconnected may be restricted from being eligible for R&D tax credits, as might salaries for overseas workers. However, you should still be allowed to include a fraction of the PAYE & NIC liability of a connected business that is delivering R&D activities for you.

There is however an exemption to be aware of, for which you need to pass a two test criteria. For the first test a business’s employees must be “creating, preparing to create, or actively managing intellectual property” – otherwise known as Patent Box Relief.

The second test is based on a calculation of fees paid to subcontractors and externally provided workers of connected businesses. This total amount must be no more than 15% of a company’s R&D expenditure. If you pass both tests, you will be exempt from the cap.

Diagnostax. R&D OVERSEAS CONTRACTORS

OVERSEAS CONTRACTORS

Finally, it’s also worth noting that contractors do not have to be based in the UK, and the R&D work they deliver for you, does not to have to be undertaken in the UK.


THINK YOU MIGHT BE ELIGIBLE TO CLAIM?

If you think you might be eligible for R&D Tax Relief, and you’d like to find out more about how we can help you navigate your R&D claim, please book a call.

Diagnostax.Fast forward your R&D Tax Credit

Diagnostax Blog 7: Fast Forward R&D Claim

With the backlash of Covid-19 and the relentless lockdowns, businesses have been hit hard. It’s hardly surprising cashflow is on every business owners mind right now. This is just one of many reasons, you might be looking to fast forward your R&D tax claim. If successful, bringing forward your R&D tax refund could be a huge helping hand for your business.

4 WAYS TO BRING FORWARD YOUR R&D TAX CREDIT

So how can a company fast forward their R&D Tax Credit?  Well, there are four routes we’re going to share with you, that are realistic options and easy to implement.

These are:

  • Shortening your year-end
  • Shortening your year-end…..again
  • Applying for advance funding
  • Getting your account filed on time
     

Before we look at the first option, let’s start with a quick recap on the timeframes. The hard and fast deadline for making a claim is two years after the end of the accounting year in which you incurred the costs. If you don’t claim within that two year window, you have missed out and there is no way to claw it back.

R&D tax claims are made via the company’s tax return which cover the same period as the company’s accounting year. You can only prepare and submit your accounts and tax return after the end of your accounting year. So in theory the earliest you can make your R&D Tax Credit claim is the day after the end of your accounting year.

R&D tax claims. SHORTENING YOUR COMPANY YEAR END

1. SHORTENING YOUR COMPANY YEAR END

Companies House automatically sets your company year-end based on the last day of the month the business was incorporated. But you can change your accounting year-end.

If you are experiencing cashflow issues, shortening your company year-end to bring the R&D Tax credit forward could be a way to get money back into your business faster. If money is tight, you should seriously consider shortening your current accounting period end, so you can make the claim as soon as feasibly possible.

Here’s an example.

A Software Company with a June year end has R&D costs of £100k and total losses of £100k up to 31 March 2021. However, they have forecasted their spend to be significantly less up to June.As a result they decide to shorten the year-end by nine months, bringing it forward to 31st March 2021. By doing this they can now submit an R&D Tax Credit claim of £33,350 to HMRC, three months earlier.

2. SHORTENING YOUR COMPANY YEAR END…..AGAIN

There’s actually no limit on how often you can shorten your accounting period year end. If you are expecting a fairly sizable credit, you could bring your year-end – and claim – forward by 6 months, say from September 2021 to April 2021, getting the cash back into your business by the June. You could then bring it forward again to the September and get even more cash into your business. The only thing to be mindful of is the fees associated with shortening your accounting period but these are likely to be minimal in comparison to the benefit of the cash to your business.

3. THERE’S MORE….ADVANCE FUNDING

There are lending companies that may lend you up to 50% of your tax credits up to six months before the end of your accounting year. The lender would need to perform a due diligence and eligibility assessment, to determine just how much they could lend you. If they agree to provide the funding the money is transferred to you, and when HMRC pays your R&D claim, you use the credit to repay the debt.

Here’s an example:

A Manufacturing company has been claiming R&D Tax Relief for three years and each year they get approximately £100k back from HMRC.They have a June year-end, but their accounts and tax usually take nine months to finalise. Advance funding is available in January 2021 for the June 2021 year-end, which would otherwise only have been received in around May 2022. This effectively brings the cashflow forward by 16 months, with only the financing cost to the client.

Diagnostax. R&D tax relief claim

4. GET YOUR ACCOUNTS FILED PROMPTLY

The earlier you get can get all the necessary company information to your accountant, the quicker they can process your R&D Tax Relief claim. You can’t do one without the other. We don’t want to be waiting to submit our clients R&D Tax Claims because we haven’t got expense receipts! It’s valuable funds waiting to come back into your business.

NEED MONEY NOW?

If you’d like to explore bringing forward your R&D tax claim, we can help you, please book a call.

Diagnostax. R&D project fails

Diagnostax Blog 8: Failed R&D Projects

Can I claim tax relief for failed R&D projects?

Failure is a reality of life, and the same applies in business. Failure comes hand in hand with innovation; it’s a by-product of learning and development. So to innovate, is to take a risk. When you start an R&D project, you have no guarantee that the project is going to be a success. You know that. That’s why R&D tax credits exist, to incentivise businesses to take that risk.

FAILED R&D IS STILL R&D

R&D tax relief is not solely aimed at rewarding successful projects, it is intended to incentivise certain behaviour in businesses. The Government Guidelines on the meaning of research and development for tax purposes, clearly state: “Even if the advance in science or technology sought by a project is not achieved or not fully realised, R&D still takes place.” (Paragraph 10)

Diagnostax. Failed R&D is still R&D

Here’s four points you should consider if an R&D project you are working on fails:

  • Not all projects achieve the advance in science or technology they are seeking:
    As long as the projects seeks to achieve an advance in science or technology and completes work to attempt to resolve the scientific or technological uncertainty, R&D applies.
  • Projects that fail can often be the most fruitful, from a learning perspective:
    The information from these projects is invaluable. The more you fail, the more you learn and get closer to your goal of success.
  • If a project fails, keep a record of why:
    If it’s a technical reason make sure you raise this with us, and that we consider this when you claim.
  • If a project fails for business, commercial or legal reasons, it’s not a failed R&D project:
    You still have to look at the advances sought, and technical difficulties and challenges faced. Provided the project meets these criteria, you can claim, whether or not you achieved the intended outcome.

FAILED PROJECTS THAT CLAIMED R&D

SOFTWARE:

Diagnostax. FAILED PROJECTS THAT CLAIMED R&D

Attempted integration of several systems for a bespoke enterprise resource planning system, where APIs were either not set up or of limited use. Significant time and effort went into trying to find a workable solution, but technical difficulties lead the project to be put on hold whilst other solutions were considered. The investment of staff time and external subcontractors had run to £120k and lead to an R&D tax refund of £25k in total.  

ENGINEERING:

Diagnostax. FAILED R&D FOR FUNDING

Development of an adjusted process to reduce waste in the manufacturing process. The company manufactures car parts and was trying to find ways to reduce the waste materials produced in the production process. After trialling three different methods and testing new materials, no significant reductions in waste were available. The project was abandoned due to other business areas becoming prioritised when the market changed due to Covid. The in-house team’s time and some materials and tooling costs were incurred, which resulted in a tax credit refund of £55k.

FAILED R&D FOR FUNDING

An R&D Tax claim can be a very welcome friend, following the financial hit of a failed project, it takes the edge off the risk and enables further investment into innovation.  It’s a great way to fund R&D projects and claw back the losses from the failed work, so you can go again. If successful, R&D tax credits can provide businesses with the funding to kickstart further projects and enable a continuous flow of funded innovation.  And innovation promotes more innovation.


THINK YOU MIGHT BE ELIGIBLE TO CLAIM?

If you think you might be eligible for R&D Tax Relief, and you’d like to find out more about how we can help you make your R&D claim, please book a call.

How will external funding affect my R&D claim?

Diagnostax Blog 9: R&D and Funding

How will external funding affect my R&D claim?

Companies often think they can only make an R&D claim if they have funded the entire R&D project out of their own pocket. There are some nuances of course but is unlikely that external funding would void a claim. Companies can receive grant funding and R&D Tax Credits for the same R&D project.

Let’s take a look at the five most common types of funding and how they could impact your R&D Tax Relief claim:

1. PRIVATE FUNDING (e.g. share equity or private loans)

There are no restrictions on making an R&D claim if the project is funded by a private funder with equity shares or loans.

For example:

£100k equity or debt funded into SME by director or private investor / investors.
£80k spent on developing app e.g. salaries, software licences, outsourced developers (this is restricted to 65%).
£80k uplifted to get additional £104k R&D tax relief deduction.
£184k can be sacrificed for an R&D tax credit of £26.7k.

R&D LARGE CORPORATE

2. LARGE CORPORATE (e.g. equity)

If your R&D project is funded by a large corporate that takes a significant portion of equity, you may only be able to claim via the RDEC scheme. This might be restricted even further if the R&D work was outsourced, or if the company has no PAYE bill.

For example:

£6m equity into SME from large corporation, taking 60% of the company.
£1m spent on developing a prototype of a new product, invested in staff costs, materials and consumables.
Up to £105,300 could be claimed as R&D tax credits under the RDEC Scheme
.

R&D Tax Credits

3. GRANTS

Many companies believe that if you receive a grant, you cannot claim R&D Tax Credits for the same R&D work. This is often not the case. However, a grant will impact your R&D Tax Credits claim, and the amount you can claim.

How it affects the claim depends on whether the grant is classified as notified state aid or non-state aid, and whether it is project specific or non-project specific.

Here is a breakdown of four key scenarios:

a. Notified state aid: Non-project-specific grant

If a grant is classified as notified state aid and is non-project specific, R&D projects you spend this funding on will not be eligible for SME relief but you can claim via the RDEC scheme. An example of such a grant is the Coronavirus Business Interruption Loan scheme (CBILS).

For example:

A £500k CBILS loan is received. The funds are not segregated by the business on receipt. £1m is then spent on 3 separate projects using the £500k CBILS and £500k of company reserves. Sadly, the projects only qualify for the RDEC Scheme in this case, meaning a maximum cash refund of £105,300.

b. Notified state aid: Project-specific grant

This relates to grants classified as notified state aid but they are project specific i.e. the grant is to provided funding for a specific project.  Any grant funds invested in the project that are eligible for R&D Tax Relief should be claimed via the RDEC scheme. However, any other funds privately invested in other R&D projects that are eligible, can be claimed under the more generous SME scheme. 

Here’s an example:

An innovate UK grant to develop a prototype machine is awarded, where 50% is covered by the grant and 50% is matched by the company using its own funds. The project cost is £1m. The £500k funded by the grant is eligible for up to 10.53% cashback (under RDEC) as is the £500k self-funded element. The company also spends £100k on a separate project, which could be eligible for the R&D SME scheme at up to 33.35% cashback.

c. De Minimis state aid grant

If a company has received less than €200,000 over three years, this grant may qualify as de minimis aid under the De Minimis Regulations. This type of grant doesn’t have to be reported to the European Commission, and is not counted as state aid. Any of the funding invested in qualifying R&D projects must be claimed via the RDEC scheme. However any private funds invested in R&D projects that are eligible, can be claimed via the R&D SME scheme. 

d. Non-state-aid grant

As with de minimis state aid grants, any of the non-state-aid grant invested in qualifying R&D projects must be claimed via the RDEC scheme. But any other privately invested funds can be claimed under the R&D SME scheme.

COVID-19 FUNDING

4. COVID-19 FUNDING

Since the launch of various emergency grants to help businesses through the Coronavirus pandemic, there has been some uncertainty about how these funds will impact R&D Tax Relief Claims. We can confirm these initiatives have been classified as notified state aid, and R&D projects you spend this funding on will not be eligible for SME relief but you can claim via the RDEC scheme.

We’d recommend ringfencing these funds, so there is a clear audit trail of how the funds were invested.

This is especially important with CBILS given the potential for it to bring all costs for all projects within the RDEC scheme, where the self-funded element might have otherwise been eligible for the R&D SME scheme

5. SEIS, EIS & VENTURE CAPITAL TRUSTS

If you have raised funds for your small business through an Enterprise Investment Scheme (EIS / SEIS) or Venture Capital Trust (VCT), you’ll need to know how these funds impact your R&D Tax Relief Claim. The good news is R&D Tax Relief can be claimed in conjunction with these funds, and there are no limitations on how those funds can be used, or the qualifying R&D expenditure.

THINK YOU MIGHT BE ELIGIBLE TO CLAIM?

If you think you might be eligible for R&D Tax Relief, and you’d like to find out more about how we can help you make your R&D claim, please book a call.

Diagnostax. R&D Recordkeeping

Diagnostax Blog 10: R&D Recordkeeping

9 R&D record keeping habits your business needs

Surprisingly HMRC doesn’t set out any specific record-keeping requirements when it comes to R&D tax claims. It recognises that every business operates differently and the way they keep their records will reflect this. HMRC also understands that first time claimers won’t have fully audited records. However, if you’re not first time claimers it is good practice to establish a reliable record-keeping system as early as possible. This will only improve the success, and possibly enhance the value of your claim refund. More funds means more projects and less chance of HMRC questioning your costs for eligibility. 

With that in mind we want to share some good practice habits to establish in your business when it comes to record-keeping.

BUT FIRST, WHY IS IT IMPORTANT TO KEEP RECORDS?

Well, the records you keep for the time and money invested on research and development are the audit trail for your R&D Tax Relief claim. To make a claim, you need to be able to realistically prove to HMRC your expenditure. The records you keep will need to: demonstrate a systematic approach to R&D activity, evidence all qualifying spend and validate any innovations made were not ‘by chance’

1.KEEP A LIST OF PROJECTS

The simplest and most effective thing you can do, is setup a list of all the R&D projects your business has worked on over the last 12 months, including any new ones. If you’re unsure whether a project is R&D, stick it on the list and start recording. It’s better to have the information recorded when it comes to crunch and then it can be ruled it in or out.

WHAT INFORMATION SHOULD I RECORD?

Here’s an overview of the key information you should be recording for each R&D project:

2. DIRECT PEOPLE COSTS

Keep a record of time spent by directors, employees, and any other qualified staff working on R&D projects. These records will be used to apportion the salary and any other costs that can be allocated to the claim. First you’ll need to identify the projects each employee worked on during the year. Then for each project the qualifying R&D activity delivered by the employee and the time taken.

Records include:

  • Salary (pension, NIC, Bonuses)
  • Reimbursed Expenses (any travel, accommodation, subsistence costs related to R&D project and reimbursed via an expense claim)
  • Time sheets if applicable (we will talk timesheets later!)

3. SUBCONTRACTOR COSTS

Keep a record of all subcontractors (connected and unconnected) working on any R&D projects. Connected subcontractors, are those where two companies are controlled by the same person or are part of the same group. A record should be kept for all ‘paid for’ subcontractor invoices. We’d always recommend splitting up the two categories to record connected subcontractor costs and unconnected subcontractor costs separately.

Records include:

  • Invoices relating to all these costs
  • Contracts
  • Time sheets if applicable

4. MATERIALS & CONSUMABLES

Keep a record of costs for all materials and resources consumed as part of your R&D project, this includes materials, water, light and heat.

Records include:

  • Invoices relating to all material costs
  • Invoices relating to water, light and heat costs

5. SOFTWARE COSTS

Keep a record of all software licences used, specifically on the R&D project. If the software was bought for use in the R&D project only, you can claim 100% of its price. However, if the software will only be used partly in your R&D project you will need to apportion the costs. 

Records include invoices relating to all these costs, and what they were used for.

6. RELATED PROTOTYPE COSTS

Keep a record of all costs linked to the design and production of a prototype needed to test the R&D project. We often see this one slip through the net!

Records include invoices relating to all these costs.

SETTING UP RECORD-KEEPING SYSTEMS

The best place to start is with the systems or processes you already have in place for record-  keeping and identifying how they can be modified or enhanced to be even more accurate. Here’s some ideas for different levels of record-keeping systems you can introduce into your business processes, starting with people time.

7. PEOPLE TIME

Cloud-based timesheets

Timesheets are perfect for recording employee time spent on R&D projects and provide a great audit trail for your R&D claim. There are loads of systems such as Meistertask, Trello, Asana and Basecamp, which you can use to record and track all project related activity, including people time.

However, these systems do require commitment and rely on timesheets becoming an integral part of your culture. Employees will need to log all the activity, and the number of hours spent against a specific project. If it can be adopted, it is a really effective way to report on employees contribution to projects. We can recommend a free app called Clockify. You can report on individual employees, or teams & R&D projects and export reports.

Spreadsheets

You don’t have to go all out and integrate a cloud based timekeeping system. Spreadsheets can do the trick. You might find it easier to get started with a spreadsheet and trial whether timesheets is something that could work for your business. The same logic applies; log projects, tasks and time spent at the end of each day. Review this weekly or monthly to ensure you have recorded all time spent.

Email calendars

If your business uses Outlook or Gmail calendars to log ALL meetings and tasks, a sensible way to trial out timesheets, is by using the categories feature. Set up a colour code system for your R&D projects and when scheduling your time apply the correct colour. At the end of each week you can very quickly estimate the time spent across different projects in the business.

Project meetings

It might be that a timesheet system isn’t right for your business, but that’s okay. If that’s the case, you could use meetings as an opportunity to take minutes and record the input from employees involved in R&D projects. You could set up a weekly projects meeting, or include an R&D slot in an existing team meeting. No one likes a meeting for meetings sake.

8. OTHER R&D COSTS: MATERIALS, CONSUMABLES, SUBCONTRACTORS

For all other costs, your accounting system will become your best friend. You can easily set up R&D codes for each project within your nominal ledger. Codes can be allocated to expenses from expenditure on, materials, sub-contractors, consumables, software licenses. However, you need to make sure that the code system is clearly communicated to everyone that will be expected to use it. We have had cases where clients have taken this a little too literally and started to record EVERYTHING under the new codes! Oops! That’s one way to get an HMRC enquiry…..

9. SUBCONTRACTOR PROJECTS

Where you are using subcontractors that also work on projects outside of the scope of R&D, it’s all about communication. Agree how you would like them to identify R&D project work and ensure they stick to it. Little tips like this just make it easier to add the invoices to your system accurately using the correct code.

THINK YOU MIGHT BE ELIGIBLE TO CLAIM?

If you think you might be eligible for R&D Tax Relief, and you’d like to find out more about how we can help you make your R&D claim, please book a call.

R&D and Patent Box

Diagnostax Blog 11: R&D and Patent Box

Can I claim R&D Tax Credits & Patent Box Relief?

If you are claiming R&D Tax Relief and you have invested in patents or other equivalent Intellectual Property, you might be eligible for another cheeky tax relief known as Patent Box Tax Relief. Like R&D Tax Relief, Patent Box Relief is an incentive designed to drive UK companies to innovate, but with the specific intention of retaining Intellectual Property in the UK.  

Read on to find out more about Patent Box Relief and how it interacts with your R&D Tax Relief claim.

WHAT IS PATENT BOX TAX RELIEF?

You may be able to make a Patent Box Relief claim if you own:

  • patents that are making your business a profit, or,
  • profitable, unpatented intellectual property which you could patent.

If you are doing one of the above activities, you may be able to make a Patent Box Tax Relief claim that could reduce your business corporation tax to 10%.

AM I ELIGIBLE TO CLAIM PATENT BOX?

To be eligible to claim, you must:

  • be a UK Limited company paying UK corporation tax, and,
  • have developed an innovative product or process, filed a patent application, and made profits that are related to the patent.

When you hear patent, you might automatically think of groundbreaking inventions but it’s doesn’t have to be this complex. Patented inventions can be as a result of a relatively small technical improvement to a product or process.

If you are put off by the prospect of a difficult, expensive process to apply for a patent, well the Patent Box Relief should provide the silver lining. For it’s not just UK profits that qualify for the relief. An amazing 100% of the company’s worldwide profits resulted from that patented product or process, could qualify for a reduction to 10% corporation tax. From 1st April 2023 that’s up to a 15% saving! Similar to R&D Tax Relief, Patent Box claims must be made before two years AFTER the end of the accounting year in which the relevant profits and income were made.  

CAN YOU USE BOTH R&D TAX RELIEF & PATENT BOX SCHEMES?

The short answer is yes. You might have thought that because the activity is all focused on innovation that there might be exemptions around being able to claim both. Wrong. The two schemes are separate but they can be combined, which is great news!

Companies can benefit from 10% corporation tax for profits related to the patented product or process, whilst claiming up to £25 for every £100 spent on Research and Development. But the savings do interact with each other. R&D tax relief reduces your profits subject to corporation tax, whilst patent box applies a 10% tax rate on profits after applying R&D tax relief and the patent box calculations.

If you’re actively involved in patents, alongside your R&D activity you need to make sure you are maximizing both schemes.  


Let’s take a look at an example..

A cosmetic dentistry business made £800k profit for the accounting period ending 31st July 2021. They expect to pay £152k in corporation tax.

They own a patent for cosmetic dentistry which was granted for the UK in September 2020. They made £100k profit from the patent.

The business also undertook Research and Development (R&D) in respect of prototyping the product which cost them £100k in this accounting period.

Firstly, they can claim an additional £130k deduction from their profits due to the R&D activities which reduces their profits subject to tax, down to £670k. This saves them £24,700.

Secondly with a patent box election, the £100k patent profits are taxed at 10% instead of 19%. This saves them £9k.

By making these claims, it means the company will now pay £118,300 in tax, resulting in a total saving of £33,700.

ELIGIBLE FOR R&D & PATENT BOX RELIEF?

If you think you might qualify for Patent Box Relief, get in touch and we will help make sure you maximise your claims across both schemes. Book a scoping call to discuss your claims.

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