The Government plans to raise investment in R&D to 2.4% of UK GDP by 2027. This is a huge financial opportunity for businesses engaged in research and development activities to receive government support.
However, the process of claiming these credits can be complex, leading to common errors that affect the success of applications and can lead to HMRC opening up an enquiry.
In this blog, we will outline seven frequent mistakes made by businesses in R&D tax credit claims, shedding light on issues that can hinder successful applications. Gain insights into why businesses often miss out on maximizing their R&D tax relief and learn practical strategies to avoid these pitfalls effectively.
SMEs, or small to medium-sized enterprises, benefit from a more generous R&D tax credit scheme. From April 1st 2023, loss-making SMEs can deduct 18.6% from their annual tax expenditure.
However, if the SME’s R&D expenditure represents 40% or more of their total expenditure, their tax relief will increase to 27%.
SMEs are categorised as:
Fewer than 500 employees.
An annual turnover not exceeding £86.12 million, Or
A balance sheet not exceeding £74.06 million.
On the other hand, large companies are categorised as:
A staff headcount of over 500.
A turnover of £86.12 million or more.
At least €74.06 million in gross assets.
Other ways to determine whether a company’s R&D claim sits under the SME or RDEC scheme include:
If the company is a member of a 51% group.
If the company has any private equity shareholders.
If the company is in receipt of grant funding.
Large companies receive a lower percentage of eligible R&D costs as tax credits compared to SMEs. The rate for large companies is typically around 10-13% of qualifying R&D expenditures.
The intent is to create a fair and proportionate system that supports innovation across businesses of all sizes.
It is crucial for companies to apply for the correct Research and Development (R&D) tax credit scheme, either the SME scheme or the R&D Expenditure Credit (RDEC), to ensure they receive accurate and maximized benefits. Misclassification can lead to significant financial implications.
The processing of R&D tax credit claims by HMRC can be a highly time-consuming procedure. The uncertainty of the HMRC approval timeline adds an element of unpredictability to a company’s financial planning.
Moreover, the delays in receiving the actual funds can strain your business’s cash flow, hindering your ability to continue operations, invest in further research, or cover ongoing expenses.
By opting for an R&D tax credit loan, your business can gain immediate access to a portion of the anticipated funds. R&D tax credit loans act as a financial safety net, providing businesses with the flexibility to access funds promptly, regardless of the HMRC processing timeline.
This ensures that your business can maintain its financial stability, proceed with planned projects, and capitalize on growth opportunities without being hindered by cash flow constraints.
Additionally, R&D tax credit loans can be instrumental in maximizing the impact of the tax credits themselves. Rather than waiting for the full HMRC approval, your business can put the funds to immediate use, such as hiring skilled personnel, or investing in necessary resources.
According to the March 2023 Spring Budget and 2022 Autumn statement, from April 1st 2023, the Government has reduced the enhancement rate from 130% to 86%. It has also reduced the surrender rate from 14.5% to 10% for non-R&D-intensive SMEs (those that invest a minimum of 40% of their total outgoings in qualifying expenditure).
Any RDEC expenditures made on or after April 1st 2023 have now increased from 13% to 20%.
RDEC is subject to corporation tax. So, it is also subject to the increased corporation tax rate, but still works out as higher relief overall
Since April 1st 2023, the Government has extended the eligibility criteria to include pure mathematics. Pure mathematics can be defined as a form of maths that has no application outside of the world of mathematics, with a focus on abstract theories.
To qualify for this expenditure, you need to make sure that your R&D activities are making an advancement in mathematics, and that you have met the other eligibility criteria.
From August 8th, 2023, an AIF is now a mandatory requirement of your R&D tax claim, and without one HMRC will automatically reject your application.
This form will cover:
Maintaining a meticulous record of all Research and Development (R&D) qualifying expenditures is paramount when claiming R&D tax credits in the UK.
HM Revenue and Customs (HMRC) require detailed documentation to substantiate R&D claims. This transparency is not only for a smoother application process, but also helps your business avoid potential audits or disputes with tax authorities.
Additionally, in the event of an HMRC inquiry, having comprehensive records readily available can expedite the resolution process, demonstrating the legitimacy of the claimed expenditures.
You can claim the following expenses as R&D costs:
A more detailed guide detailing what specifically can be claimed within those categories can be found here.
Maintaining detailed records also maximizes the amount of claim eligible. By meticulously documenting every qualifying expense, you can ensure that your business has captured the full scope of your R&D activities. This, in turn, allows you to claim the maximum tax credits to which you are entitled.
For example, when claiming materials that were used in your R&D process, there can be somewhat of a grey area when separating consumables such as water bills into R&D-related expenses, and not R&D-related.
While HMRC claim to adopt a pragmatic approach to this type of expenditure on indirect activities, having transparency with meticulous records will minimise disputes over these details.
A common mistake seen by R&D financial support services is that companies will only claim staffing costs for those who were directly involved with the R&D process. However, you can also claim for any costs associated with maintenance, clerical support, and personnel activities, such as managing or supervising PAYE employees who were directly involved in the R&D process.
When claiming R&D qualifying staff costs, you can claim for the following:
Before finalising your expenses, you need to organise them into either in-house costs, or subcontracted costs.
Once this has been established, you then need to submit your subcontracted expense claim according to whether your business is an SME or a large company.
Large companies can claim back 100% of the costs of any work that is directly undertaken by:
This does not include any research and development activities that took place abroad.
Under the SME scheme, you can claim up to 65% of the payments made to subcontractors, as long as the subcontractor is not connected to the company.
If the subcontractor could be considered connected to the company (such as having the same shareholder), the claim will be the lowest of either:
Inflating your R&D expenses can have incredibly serious consequences for your business. If an enquiry were to find that you have inflated your expenses, or finds errors with your expenditure application, the penalties charged can be up to 70% of the total claim value, with interest on top.
If the inflation is considered to be deliberate or severe, it could also result in criminal investigation and prosecution.
Following April 2023, a further 100 inspectors were added to the HMRC tax relief teams to tackle those abusing the SME scheme. In addition to this, they have added a number of strategies and tools to crack down on the perceived amount of fraud in the SME scheme.
A major rule for businesses to be aware of is that any accountability for an inflated R&D tax relief claim is assigned to the business, and not their accountant or R&D tax relief advisor.
R&D tax relief boutiques do not have the same regulations as accountants, and some may submit claims that are inflated, or containing errors. It is therefore of utmost importance that the business does its own due diligence in ensuring that all paperwork and expense documentation is correct.
To efficiently maximise your R&D tax credit claim as a business, it’s crucial to accurately classify your size for R&D claims and consider using R&D tax credit loans to manage cash flow while waiting for government reimbursement.
Stay informed about changes in R&D policies to adapt and maximize benefits, and keep meticulous records to avoid oversights in qualifying R&D expenditure and staff costs.
By addressing these areas, your business can enhance the chances of a successful R&D tax credit claim, optimizing financial support and fostering a culture of ongoing innovation.