The small business guide to research and development tax credits

Digital and innovation

21 August 2018

Innovation can be key to setting yourself apart from your competitors and growing your small business.

However, due to the everyday commitments and responsibilities that come part and parcel with running a business, it can be difficult to dedicate time, resources and money into small business research and development to come up with the new ideas and products needed to help your business grow.

That’s where the government’s research and development tax credits can help. R&D tax credits reward UK businesses that invest in innovating their business via the products and services they offer. However, this tax relief is still vastly underused by SMEs. With the average annual claim coming in at £54,214 for SMEs alone, it's time to talk about how – and why – your business should start claiming.

What is R&D tax relief?

Introduced in 2000, the R&D tax relief scheme is designed to encourage small businesses to spend more money and time on researching and creating new products and services or honing existing ones by reimbursing them via a cash payment or corporation tax reduction.

Your business pays for the R&D development activity, then when you pay your taxes, you can deduct the allowed cost of R&D from your tax bill. For R&D tax, you can claim 230% of tax relief. For example, if you spent £1000 on research and development, you could claim £2300 off your corporation tax bill. If your company is in the red at the end of the tax year, it can claim a tax credit of up to 14.5% of the surrenderable loss as cashback.

However, there’s a strict set of guidelines of what counts as research and development in relation to this tax relief.

How do I know if my business is eligible for R&D relief?

SME R&D relief is available to companies with fewer than 500 staff, a turnover of less than €100 million or a balance sheet of less than €86 million. The definition of a small business in relation to R&D tax relief differs from the definition of a small business for other areas of corporation tax, such as PAYE. As such, make sure you’re using the appropriate definition of what a small business is when applying for R&D tax.

If your business is part of a bigger company – whether a franchise or a distribution company – then you must take the whole company into account, not just your part of the business.

For your project to be eligible for the scheme, the research and development you carry out must be related to your current business – or one that you want to launch if the research phase is successful. There’s no restriction on attaining these tax credits in relation to business sector, so small business from a wide selection of industries can take advantage of R&D tax credits.

Fundamentally, your project should aim to develop a new product, process or service, or improve on something that already exists. Apparently, the secret to success is preparation, hard work and learning from failure. R&D tax recognises that businesses have to take risks in order to innovate and as such, failed projects are also eligible for R&D tax relief as HMRC recognises that not all ventures will be successful.

How to claim R&D tax credits

To claim the tax credits, you need to write a proposal proving that the research and development your business is proposing to carry out makes in advance in your field, where you’re a business owner or a retailer.

This proposal should contain how your project:

  • Involves a new development in your industry.
  • Had and attempted to overcome any uncertainties – such as a simple description of the successes and failures you had during throughout the project’s duration.
  • Solves a problem or satisfies a need that hasn’t already been worked out by any other companies or bodies within your professional field.

Once you've assessed and calculated your R&D expenditure, you submit the final figures in the CT600 portion of your tax return. Remember to claim within the two years after the end of the corporation tax period when the project took place.

What can I claim for?

Carrying out a research and development process can incur a lot of different types of costs. Thankfully, R&D tax allows you to claim back the money spent on a variety of outgoings. If your project meets the criteria listed above, you can claim for a number of expenses, including:

  • Staffing costs including salaries and pension contribution.
  • Materials and consumables (such as power, light and heat) that are utilised throughout the R&D process.
  • Software license fees.
  • Hiring additional staff such as freelancers and subcontractors to help complete your project.

Examples of how R&D tax credits can be used

Having access to the scheme gives small businesses the opportunity to be more experimental and R&D tax credits act as kind of security net if the project ultimately fails. As long as the R&D follows the above guidelines, innovations in retail, such as the following, would be eligible:

A bakery developing new ways to make gluten-free cakes 

Creating the chewy texture of gluten without the addition of wheat flour would be a positive development, and may involve a partnership with a food science laboratory.

Building a bespoke e-commerce platform for your business

Many small retailers use templates or online stores like Etsy and Shopify to sell products online, but R&D tax credits could help you to develop your own unique platform which enhances the customer experience.

Designing fully compostable packaging

Single-use plastics have been hitting the headlines recently due to their negative environmental impact. Working with manufacturers to create packaging products that are completely compostable, and better than existing products, would qualify for R&D tax credits – and would provide plenty of positive publicity for your business.

If you're planning to innovate within your sector, it's well worth discussing R&D tax credits with your tax advisor. Not only could it help to strengthen your brand and commercial success, it could also help you to differentiate your business from your competitors, giving you a competitive edge.

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