Research and Development (R&D) - Improvements and Issues

In 2000, an R&D tax credit was introduced for small and medium-sized companies (SMEs). SMEs can claim tax relief on 150% of qualifying R&D costs or, if the company is loss making, claim a cash refund equal to 24% of the expenditure (but capped at total PAYE and NIC payments made in the year). The scheme was extended to large companies in 2002 enabling them to claim relief on 125% of qualifying expenditure but not providing for a cash refund alternative. A number of beneficial changes have recently been made to the schemes. These include:

• the annual threshold for qualifying expenditure is reduced to £10,000 (from £25,000) which should help in particular SMEs spending relatively modest amounts on R&D
• qualifying expenditure now includes the costs of workers paid through a third party which should help the IT industry where paying workers through an agency is very common
• the calculation of qualifying staff costs has been simplified.

However the most difficult aspect of the schemes is often determining what expenditure qualifies. That which does is limited to

• staff costs - so long as they are directly and actively involved in the R&D
• costs of ‘consumable stores’ - ie material and equipment used in the R&D
• certain sub-contracting costs if the business retains the right to the knowledge that is produced.

Additionally, expenditure will only qualify if the primary objective of the research activities is innovative or creative in the fields of science or technology and undertaken to extend knowledge. The application for a patent for a new product is always helpful in this regard. Furthermore the project must be undertaken in a systematic way and there must be demonstrable technological or scientific uncertainties as to its outcome. For example, the Inland Revenue accepts design, construction and testing of a pre-production prototype as typical of qualifying research whilst market research will not qualify.

Deciding what does and does not qualify is never easy. It may be easier in certain sectors than others; for example the pharmaceutical industry tends to experience fewer problems with the relief than the computer software industry. The Inland Revenue is aware of these difficulties and is looking at ways of clarifying the definition of qualifying R&D. In the meantime please talk to us if you are planning a new R&D project so that we can help you to maximise the available relief.