How are UK R&D tax credits calculated for SME R&D claims?
Understanding how UK Research and Development (R&D) tax credits are worked out and what value they bring to a business is not always straight forward.
Below I set out the fundamentals.
This article should give you a clear view of how UK R&D tax credits are calculated and what the benefits are for Small and Medium Enterprises (SMEs).
BACK | FORWARD
The first point to firmly grasp is that UK R&D tax credits and relief can only be claimed by UK registered limited companies. There are two schemes:
- SMEs R&D tax credit/relief for limited companies with under 500 employees; and
- RDEC for large companies with over 500 employees.
The benefit a company gets is based on how much it spent on qualifying activities in the relevant accounting/tax year. The qualifying spend is known as its R&D costs.
For SMEs the R&D costs and benefits are claimed as part of the company’s annual Corporation Tax Return and associated Tax Computation (this is usually compiled and submitted by its external tax accountant). So an R&D claim does not change an SME’s pre-tax Trading Profit or Loss as reported in its Annual Company Accounts.
A quick recap on how corporation tax works
To understand how R&D tax credit works you need to understand how corporation tax works so here’s a basic summary:
- A UK limited company pays Corporation Tax (CT) on the money it makes each year – i.e. its profit.
- Its profit for CT purposes is all income minus all expenditure and other any other allowable deductions (such as capital allowances).
- The amount of CT payable on its profit is determined by the government’s CT rate – i.e. in 2017/18 the CT rate was 19%, so a company’s CT bill will be 19% of its profit (i.e. £19 paid in CT for every £100 of profit).
- If the company did not make a profit because its expenditure was greater than its income, it can carry forward its loss, to use to offset any profit it makes in the future, thereby reducing its future CT bills.
- Or if had had a profit in the immediately preceding year it can carry back its loss to use to offset some or all of the profit made in that year - this will result in a repayment of CT assuming the CT has already been paid.
Here’s how R&D tax credits work
An SME R&D tax credit claim creates an additional deduction in a company’s annual corporation tax computation. The additional deduction is worked out by multiplying the company’s R&D costs by x 130%, so R&D costs of £100K would yield an additional deduction of £130K. The impact and benefit from the additional R&D reduction, which is known as the R&D Enhancement, will depend on the specific circumstances of the company.
Where a company has a profit
If before calculating the R&D enhancement a company has a taxable profit the R&D enhancement will either:
- Reduce its taxable profit and therefore it will pay less CT; or
- Turn its taxable profit into a loss and therefore it will pay no CT, plus it has the options of
- if it was profitable in the prior year - carrying back the loss to offset a profit in the prior year (this will result in repayment/reduction in CT payable in the prior year);
- carrying forward its loss to use to offset a profit it makes in the future (so less CT to pay in the future);
- surrendering its loss for a cash payment (rather than carrying it forward).
Where a company has a loss
If before calculating the R&D deduction a company has a loss the R&D enhancement will:
- Increase its loss giving it the options of
- if it was profitable in the prior year - carrying back a larger loss to offset a profit in the prior year (this will result in repayment/reduction in CT payable in the prior year);
- carry forward a larger loss to use to offset a profit it makes in the future (so less CT to pay in the future);
- surrendering its loss for a cash payment (rather than carrying it forward);
Value and benefit of surrendering a loss for a cash payment
If a company chooses to surrender its loss for a cash payment the payment is calculated as 14.5% of the value of the loss surrendered, while if it carries forward the loss to use to offset future profits the benefit is going to be at the relevant CT rate (in 2017/18 the corporation tax rate was 19%). So, for example, assuming the relevant loss is £100K:
- If £100K is surrendered for a cash payment the company will receive £14.5K in cash.
- If £100K is carried forward and the company is able to use that £100K to offset a profit of £100K in the following year, the CT saving will be £19K (£100K x 19% corporation tax rate).
So the choice is cash now at 14.5% of the value of the loss surrendered, or reduced CT in the future at the higher corporation tax rate of 19% (or whatever the corporation tax rate is when the loss is used to offset a profit).
Note that the loss that can be surrendered for a cash payment is limited to the company’s R&D costs x 230% (or to put it another way: its R&D costs + its R&D enhancement).
What if the company already has a loss available to offset profits?
Let’s look at a scenario where in the relevant year:
- the company still has a profit after the R&D enhancement has been deducted, and
- it also had a carried forward loss that it has brought forward, sufficient to cover its profit.
In this scenario it’s not going to have any CT to pay because it can offset its profit using its brought forward loss, and it does also not have a loss that it can surrender for a cash payment as it made a profit (only a loss created in the relevant year can be surrendered for a cash payment). So there is no immediate benefit from the R&D claim. However there is still a benefit as the R&D enhancement offsets a portion of the profit. This means that an equal portion of the brought forward loss is not needed to offset the profit, so it is preserved to carry forward to use to off offset a profit in the future, thereby reducing future CT bills.
Are you ready to find out if you qualify or how much your R&D claims could be worth?